Industrial Policy: a Theoretical and Practical Framework to Analyse and Apply Industrial Policy 2

Module 2 Industrial policy: a theoretical and practical framework to analyse and apply industrial policy 2

module Industrial Industrial policy: a theoretical and practical framework to analyse and apply industrial policy 68 governments should have an industrial policy in policy industrial an have should governments riences. The aim is to answer the question of why expe- American Latin and Asian East the around ing with a brief summary of the historical debate start policy,industrial against and of favour in arguments reviews 3 Section implementation. and design policy industrial successful of ples - princi and conditions key the discusses also It instruments. policy industrial classified and icy pol- industrial defined has literature the how of overview an provides 2 implemented. Section be can policy industrial an how discuss and mation the role of industrial policy in structural transfor on debate the survey we so, doing In process. a discusses how the government can such support module economy. This an in changes structural that the process of development entails profound teaching material,this In Module 1 of we learned trial policy. but how to best design and implement an indus- haveto policy,industrial an whether not is today countries alike. The issue governmentsmost face developing and developed of agenda policy the financialcrisis, have put industrial policy global back on 2007-2008 the from fallout the cluding economy,in - world the in developments Recent support. and intervention state consistent and careful require rather but autonomously, place take always not do innovation and upgrading, technological transformation, Structural ment. transformationstructural spurring develop - and countries, many to beneficial been has policies industrial of use the that suggest accounts cal - histori module, this throughout see will we As a revived interest inindustrial policy. context,this growth,and, in economic stimulate and unemployment reduce to pressure public More recently, however,there has been increased policy.industrial an have to not is policy dustrial in- best the that argue to economists some led even view This goods. public providing or tion competi- increasing by efficient more outcomes market make to try that policies to intervention more a towards market-centeredapproach,government limiting shifted policy development 1980s, early the society. In to beneficial most would be that ways in activity economic mold to state a of ability gov the and of intervention ernment importance the emphasized Prebisch Raúl Albert and Gerschenkron, Rosenstein-Rodan, Alexander Hirschman, Paul as such mists econo - development has and political profession Early existed. economics the as long as of conten- tion issues been have specifically, more policy industrial and intervention, Government Introduction 1 - - - able to: be able should students module, this of end the At to analyse andapplyindustrial policy. framework practical and theoretical a both with reader the provide to is module the of objective overall The policymaking. industrial influencing factors external and internal between guishing distin- countries, developing in policies dustrial in- to challenges current the of some discusses 5 Section policies. industrial successful less and successful of examples some providingmatters, practical more to moves 4 place. Section first the What 2 i.e. equilibrium”the market in [emphasisadded]. intervention,such of absence the in occur would than growth economic for prospects better offer of production toward sectors that are expected to structure the alter to attempts that policy ment of type “any be to policy industrial consider 2) (2006: Saggi and narrower policy. instance, Pack industrial For of provide definitions 2006) Saggi, and Pack 1992; Landesmann,2009; (Chang, authors Other thor]. au- original the by intervention”[emphasis such of absence the in occur would than welfarecietal or growth foreconomicoffer prospects better sectors, of structure the alter to attempts intervention of type as“any policy industrial defines 16) (2013: wick War definition, broad a Adopting concept. this industrial policy, which of reflects the controversy surrounding definition consensual no is There 2.1 uses,ments it canbeimplemented. andhowit - instru policy policy,what industrial an stitutes con- what explains section this scholars, policy tries. Based on the views of counthe - leading industrial different considerably across and varied history throughout have policy implementation industrial the of and definition the Both • • • • • policy Definingindustrial cies in the context ofadeveloping in economy.cies poli- industrial to challenges the Understand dustrial policyinstruments; and in- specific with experiences country Analyse dustrial policies; in- of role the differenton the views Describe industrialto implement policies; used be can that instruments policy the Describe designedandimplemented; can bebest it how and is policy industrial what Explain that are expected to to expected are that tasks or technologies or environmentor business the improve to policy? isindustrial nevnin r govern - or intervention selective or government policy that that policy government or toward activity economic so- - Industrial policy: a theoretical and practical framework to analyse and apply industrial policy 2 2.1.1 Functional or selective industrial policies? in choosing where to build a road – is always pre- sent in policymaking. module As we will see throughout this module, the issue of how actively industrial policy should seek 2.1.2 Which sectors deserve support from to alter the structure of economic activity is at selective industrial policies? the heart of the discussion on industrial policy. More precisely, the debate has focused on how Some authors have specified the characteristics selective industrial policies should be, i.e. to what that such sectors must have. They must have extent industrial policy should target (select) export, job, and knowledge creation potential specific sectors, technologies, or tasks in order (Reich, 1982), and they must be new to the econ- to alter the structure of the economy towards omy (Rodrik, 2004). Ocampo et al. (2009) include them. Using Warwick’s (2013) words, policies that dynamic effects by specifying that industrial attempt to improve business environments have policy should aim to restructure the economy been commonly referred to as functional, or and trade specialization towards activities with horizontal, industrial policies. Policies that alter higher technological content and promote inno- the structure of economic activity towards spe- vative activities with strong linkages to the rest cific sectors have been referred to as selective, or of the economy. In their view, innovative activities vertical, industrial policies.36 Functional policies should be understood in a broad sense as new 36 Some authors have sug- would be the least interventionist because they technologies, but also new markets, industrial gested different terminolo- are designed to support the operation of markets structures, or exploitation of previously underu- gies: soft and hard industrial policies (Harrison and Rodri- in general. Examples include policy measures tilized natural resources. Finally, tension exists guez-Clare, 2010), pro-market that facilitate entry of firms through competition between promoting structural and technologi- and pro-business policies policy, or trade policies that liberalize imports. Se- cal change through productivity growth and (Rodrik and Subramanian, lective industrial policies aim to promote certain achieving an acceptable quantity and quality of 2005), and market-based and industries and firms over others. They can make employment, as higher productivity in an indus- promotional policies (Weiss, 2013). use of subsidies and other forms of support and try reduces employment (see Module 1). Noting protection such as import tariffs and restrictions, this, Salazar-Xirinachs et al. (2014: 2) call for a pol- tax incentives, and public procurement. icy that can “strike a good balance in achieving the two fundamental objectives of productivity Some authors (Lall and Teubal, 1998) have further growth and more and better jobs.” divided functional/horizontal policies into two distinct categories. This approach has also been Given these characteristics, manufacturing is the followed by UNCTAD and UNIDO (2011: 34), which most common target of industrial policies. Nev- describe industrial policy as involving “a com- ertheless, some authors, such as Rodrik (2004: 3), bination of strategic or selective interventions caution that “industrial policy is not about in- aimed at propelling specific activities or sectors, dustry per se. Policies targeted at non-traditional functional interventions intended at improving agriculture or services qualify as much as incen- the workings of markets, and horizontal inter- tives on manufactures.” Especially in economies ventions directed at promoting specific activities heavily dependent on agriculture, industrial poli- across sectors.” Following this literature, horizon- cies should simultaneously spur investments in tal policies go slightly beyond functional policies, productivity improvements and technological as they aim to promote cross-sector activities change in agriculture that lay the foundations for which markets are missing or are difficult to for manufacturing and services expansion (Szir- create (a typical example is innovation policy). mai et al., 2013; UNCTAD, 2015a). Hence, horizontal policy would lie somewhere between functional and selective industrial policies. 2.1.3 Should industrial policy conform to or defy comparative advantages?37 37 For a review of the concept As several authors have argued, the distinction of comparative advantage, between functional and selective industrial Authors have disagreed on whether industrial see Box 1 in Module 1 of this teaching material. policy might be less relevant than what the lit- policy should be comparative-advantage-con- erature has suggested, as “even the most ‘general’ forming or defying (Lin, 2011; Lin and Chang, policy measures favour some sectors over others” 2009). The argument in favour of comparative- (Salazar-Xirinachs et al., 2014: 20; see also Rodrik, advantage-conforming industrial policy is that 2008). For example, infrastructure investments, governments in developing countries should first generally considered a functional industrial poli- focus on the industries where they have a com- cy, favour a certain region and the industries that parative advantage (i.e. resource- and labour-in- populate it. Similarly, training programmes aim tensive industries). Only when they accumulate to create knowledge and skills in specific techni- sufficient physical and human capital should cal areas. Moreover, prioritization – for example they upgrade their industrial policy and target

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module picking winners. understood asasynonym for national championscanbe industrial policies. Nurturing and otherforms ofselective protection,market subsidies, throughnational champions pions” meanssupporting national cham- “nurturing 3.2). From here,the phrase (seealsoindustry Section the other characteristics of to anational interestdue or strategic industries, either the statein by nurtured created domestic firms or literature, refersto large champion”, recurrentthe in 38 38 Industrial policy: a theoretical and practical framework to analyse and apply industrial policy The expressionThe “national 70 dynamic comparativedynamic advantage. their realize and discover countries help should policy industrial view, this following Therefore, advantages. comparative static following than industries,rather and sectors new entirely ating building comparativeabout advantages and cre- is policy industrial that argues (1994) rea,Chang Ko- of Republic native policy.his of example the Using industrial comparative-advantage-conforming defend who those by for accounted straightforwardless than is machinery adapting and higher-productivityactivities to lower-from workers Retraining upgrading. and learning for possibilities few with sectors low-productivity low-value-added, in is that advantage parative com- static coun- their to according specialize constrain to tries would competitive, and free markets making at aimed those policies,as industrial such comparative-advantage-complying Moreover, activities. skill-related and nological tech- advanced more to point entry an as serve or growth economic sustained of engine an as act cannot industries such However,industries. labour-intensivein only – markets global in pete com- can and – advantage comparative a have labour cheap of abundance an with countries developing comparative- that a is strategy of advantage-defying defense in argument The comparativetheir latent ize advantage. facilitatingrole,a play realfirms - should helping government the therefore, view, this Following industries. those entering of benefits the than higher much were firms these protect to curred in- costs and costs production mistake”,fatalas “a called 66) (2014: Treichel and Lin what to led industries. This those in advantage comparative a had that countries in than higher much were costs production resource, scarce a was capital because industries: capital-intensive) (i.e. heavy into move to countries developing led policies industrial comparative-advantage-defyingview, this to According industries.higher-productivity have been undertaken anyway by private firms. would that investments support that refers policies to latter the and champions, national and opportunities business new potential creating thereby invest, not would firms private where invest governments which through policies to refers former The policies. market the following Wade (2010) to talk about leading the market and led consideration This winners. pick than rather create to need governments countries veloping winners is often misleading because in many de- picking about speaking that argued have 1990) Cimoli 2001; (Amsden, ers (Aghion rent-seekinggenerated that, policies industrialarbitrary, lective being by se- of use arbitrary more the to refer to it used have Others 2006). Saggi, and Pack 2002; Pack, and (Noland policy industrial selective for nym - syno a this considered have Some ways. ferent uses the notion of “picking winners”, albeit in dif The literature on industrial policy also frequently degree ofgovernment intervention. different a implies categories these of Each cies. and leading the market versus following market poli- policies; comparative-advantage-defying ners;comparative-advantage-conforming versus win- creating versus winners picking about talk to and policies industrial selective of category broad the within distinguish further to authors some led has This disagreement. considerable while selective industrial policies have accepted,generated widely most the are policies dustrial in- horizontal and functional consequence, a distortive. As and active most the considered are thereafter.mediately policies industrial Selective inter im- followpolicies. Horizontalventionist policies least and neutral, general, most the are policies intervention.industrial ment Functional governpolicies,of - tivedegree the on depending and selec- horizontal, functional, into classified been have policies said,industrial we As section. this in discussed categories policy the of tation represen- visual a presents 25 up,Figure Tosum 20; Wade, 2009; al., et , 2011). Oth- 2011).al., et 38 - - Industrial policy: a theoretical and practical framework to analyse and apply industrial policy

Figure 25 2 A visual representation of industrial policy categories module Functional industrial policies (aimed at improving the workings of markets)

Horizontal industrial policies (aimed at promoting specific activities across sectors)

Selective industrial policies (aimed at propelling • Picking versus creating winners specific activities or sectors) • Comparative-advantage conforming versus comparative-advantage-defying • Leading versus following the market

Source: Authors' elaboration.

2.2 Industrial policy instruments In this regard, the main advantage of the Weiss (2015) classification is that it distinguishes in- There are three dimensions of industrial policy dustrial policy instruments that are available to that are sometimes confused in the literature: (a) countries with different income levels. overall vision or strategic direction; (b) industrial policy instruments; and (c) the process of industri- Table 5 shows the policy instruments available al policymaking (Weiss, 2013). This section focuses to low-income countries. In the product market on industrial policy instruments, which are the domain, market-based policy instruments aim tools that governments have at their disposal to to increase the profitability of manufacturing implement industrial policies. In the literature, in- activities. Import tariffs and export subsidies dustrial policy instruments have been classified in have been among the most important instru- various ways, i.e. with different attributes.39 Some ments used in East Asia and Latin America. While 39 For a review, see Guad- authors have used the categories described in not completely prohibited under the new global agno (2015a). Section 2.1, distinguishing between functional, trading regime, today the use of these instru- horizontal, and selective industrial policies; others ments is restricted or discouraged (see Section have distinguished according to policy domains.40 5.2.3). Therefore, alternative instruments, such as 40 Some have also used the For example, Di Maio (2009: 107) distinguishes be- duty drawbacks and tax incentives, can be used. expression “area of inter- tween innovation and technology policies, edu- Among the instruments that do not directly af- vention” to refer to policy domains. cation and skill formation policies, trade policies, fect prices are public procurement, but also (less targeted industrial support measures, sectoral costly and less controversial) instruments such competitiveness policies, and competition-regu- as services to reduce information asymmetries lation policies. Warwick (2013) differentiates be- (organization of fairs, linkage programmes, and tween policy instruments that affect the product other services that facilitate domestic and for- market, capital market, labour and skills, land, eign investments). In the capital market domain, technology, and systems/institutions. directed credits and interest rate subsidies (both market-based instruments) as well as develop- Partly following Warwick (2013), a recent clas- ment banks (a public goods instrument) played a sification proposed by Weiss (2015) identifies key role in the industrialization strategy of first- five categories of industrial policy instruments: tier East Asian newly industrialized economies those related to the product market, labour mar- (NIEs) (see Sections 3.1.2 and 4.3). In the land market, capital market, land market, and technology. ket domain, public goods instruments such as Instruments are further categorized into market- export processing zones (EPZs) and special eco- based instruments, defined as instruments op- nomic zones (SEZs), which are among the most erating through pricing, and public goods, refer- popular instruments in developing economies, ring to the provision of goods and services that have been used to attract foreign investment private firms would not supply on their own. (see Section 4.4.2). Through EPZs and SEZs, governments can provide foreign firms with high- It is important to note that a number of indus- quality infrastructure, including reliable energy trial policy instruments are expensive, meaning supply and fast Internet connections, and offer that governments need considerable fiscal re- various tax incentives to compensate for the sources to implement them. This in turn requires possible difficulties that firms might encounter fiscal capacity, i.e. the ability of the state to collect by moving to their country. In the domain of tech- taxes, and adequate fiscal space (see Section 3.3). nology, given the limited skill levels and financial

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module Industrial Industrial policy: a theoretical and practical framework to analyse and apply industrial policy 72 iiae h bopin f oeg nweg by knowledge foreign of absorption the cilitate fa- to aim should instruments policy industrial economies, low-income in available resources Notes: EPZs: processing zones; export FDI: foreign investment; direct R&D: research anddevelopment; SEZs: special economic zones. Source: Weiss (2015: 23). Notes: EPZs: processing zones; export FDI: foreign investment; direct SEZs: special economic zones. Source: Weiss (2015: 9). and administratively capable, governments can can governments capable, administratively and pabilities and the state becomes more technically Similarly, ca- and knowledge accumulate firms as fields). technological new in projects innovative potential (e.g. growth high profile and high-risk a with projects to ventureprovidecapital to ments govern- country,allowing the of development of level the with alongogy. develop markets Capital in domains:policy two technol- capitalmarkets and found are instruments These development. and industrialization sustain and strategies trial indus- their upgrade to introduce can countries middle-income that instruments policy dustrial in- complex and costly more identify to us lows middle-income al- Tablewith 5 table this Comparingeconomies. to instruments policy dustrial in- of classification previous the tailors 6 Table Product marketProduct Product marketProduct Labour market Labour market Capital market Capital market Land market Land market Technology Technology Table 6 Table 5 Policy domain Policy domain backs, credits,tax investment/FDI incentives tariffs, Import subsidies, export dutydraw investment/FDI incentives tariffs, Import dutydrawbacks, credits,tax Wage credits/subsidies,tax training grants Wage credits/subsidies,tax training grants Directed credit, interest rate subsidies Interest rate subsidies, loanguarantees Subsidized rental Subsidized rental R&D subsidies, grants inmiddle-income economies policies Industrial inlow-income policies Industrial economies Market-based Market-based and innovation 4.4.1). network(seeSection knowledge base and established a strong research government,the by supported ly created stronga tia and research institutes, initiated and financial- regard:this researchpublic-privateconsorin ing illuminat more once is economies Asian East of institutes. experience research and The consortia research public-private supporting and lishing estab - include markets affect directly not do that fields).scientific or technological Instrumentsing promis- advance to resources financial of ments R&D), grants (disburse- in and investing firms for rebates, tax or rates, interest subsidized with its research(credsubsidies development(R&D) and - instruments: policy market-based two includes classification the domain, technology the In tion. innovaofferstimulate incentivesto of number - a programmes, bothpublicgoodsinstruments. extension and transfer technology supporting - Instruments Instruments investment promotion agencies FDI country marketing, one-stopshops, information/trade fairs, linkage programmes, Procurement policy, market export investment promotion agencies FDI country marketing, one-stopshops, information/trade fairs, linkage programmes, Procurement policy, market export Training institutes, skills, councils Training institutes, skills, councils Loan guarantees, development banklending second tier) lending,second venture capital Financial regulation, development bank(first/ extension programmes Technologytransfer support,technology legislative change, programmes incubator EPZs/SEZs, factory shells, infrastructure, legislative change, programmes incubator EPZs/SEZs, factory shells, infrastructure, technology extensionprogrammes search institutes,transfertechnology support, Public-private research consortia, publicre- Public goods/direct provision goods/direct Public Public goods/direct provision goods/direct Public - - Industrial policy: a theoretical and practical framework to analyse and apply industrial policy 2 2.3 Implementing industrial policy start with two over-arching strategic principles that should serve as the guide for effective indus- module There is no set rule as to how countries should trial policy implementation. First, state initiatives design, coordinate, and implement an industrial must be pro-active, selective, and focused on the policy. Successful cases have come through vary- long term, rather than simply tied to the electoral ing constellations of histories, institutional as- cycle or the need to gain popular legitimacy over sets, time frames, natural resource endowments, the short term to remain in power. Here the prob- and other factors. This means that there is not lem of carefully “picking winners” (and getting one simple “recipe” for industrial policy success. rid of “losers” over time) is of particular relevance. Instead, economic history shows that while it is The government has to proactively seek solutions important to learn from the experiences of oth- to cope with the problems faced by industry and er countries (both successes and failures), each improve government support to it in order for country has to individually experiment and learn businesses to upgrade towards more productive by doing when establishing its own industrial and value-adding activities. The second strategic policy programmes. imperative is to stress the inter-connectedness of the industrial development and structural trans- Despite these country specificities, various au- formation process, as well as the need to forge a thors have produced some general advice on how common vision for collective action. The authors to effectively design and implement industrial argue that public-private alliances are a means to policy. This concerns two main aspects of indus- accomplish this crucial task. Such structures al- trial policymaking processes: (a) how to build an low for information sharing and collective action, institutional setting capable of implementing but preclude the possibility of the state being policies effectively; and (b) how to manage the “captured” by private interests. delicate relationship with the private sector. Devlin and Moguillansky (2011) also provide a list Devlin and Moguillansky (2011) outline a set of of operational principles that the public sector strategic and operational principles that they could implement when designing and pursuing argue have emerged out of the good and bad an industrial policy (see Table 7). experiences of a wide range of countries. They

Table 7 Key operational principles of industrial policy Principle Key issues Give the baton to the “real” sector ministries. Technical leadership of an industrial policy must be in the hands of key ministries (e.g. industry ministry, or trade and industry ministry) and executing agencies.1 Promote medium- and long-term strategic thinking on policy. This point emphasizes the importance of allowing ministries and executing agencies sufficient time to design and implement an industrial policy. Like governments themselves, bureaucratic units can get trapped into a short-term mentality that discourages strategic thinking and careful action. Each priority area or activity in a strategy should have at least While acknowledging the problem of coordination, effective one dedicated implementing agency. industrial policy requires dedicated specialized units to manage and oversee an industrial policy programme. Each main function required in the industrial policy might best be assigned to a responsible agency.2 The more structured and specific a strategy, the greater the Coordination of an industrial policy programme is a difficult need for coordination among ministries and agencies and task in practice, but its implementation can be facilitated by the more likely it is that higher-level coordination will not be establishing a clear mandate and hierarchy of functions for enough. each agency involved. For medium- and long-term strategies to be effective, public Competent and meritocratic bureaucracies are widely seen sector personnel must be highly professional, career-oriented, as a linchpin for the success of industrial policy. This requires and non-politicized. competitive recruitment, above-average salary and/or working conditions, extensive life-long (technical) training, promotion by merit, and insulation from politicization.3 The effective application of incentives must be assessed not Sectors and activities are often interconnected. Coordination only by how they are individually managed but also by how of incentives across agencies is therefore important to guar- they are coordinated for a systemic effect. antee policy coherence and maximize the long-term impact of industrial policies.

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module Industrial Industrial policy: a theoretical and practical framework to analyse and apply industrial policy 74 Japan, seeUNCTAD (1994). used andcould beusedfor effective industrial policy, seeSchneider(2013, 2015). Onhowdeliberation councils have beenusedin the private andgovernmentchange andsocial between learning sector bodies. For review adetailed ofhowcouncils have been 4 Coordination canbestrengthened byentrusting coordination canfacilitate anddeliberationthat information councils ex this issue,3 On seealso Evans (1998)andRoll (2014). office,tax bankismorement than a competent thensubsidizedcredits shouldbepreferred incentives. tax over inanefficientpolicy instrument thanafirst-best ineffectively. instrument setting For example, according to Rodrik, ifadevelop- location ofcompetence shouldbeprioritized overthe choiceofpolicyinstruments, industrial to useasecond-best isbetter asit them.and empower competence.than creating even might ofuncertain This newagencies bebetter the that alsoThis means 2 offunctions,the assignment to With respect governments competent Rodrik agencies that the most identify (2004)suggests the Republicin ofKorea andSingapore,the Council and onEconomic PlanningandDevelopment in Taiwan Province ofChina. ofInternationalthe Ministry include Tradetext), (MITI) andIndustry inJapan(seeBoxthe main 8in the Economic PlanningBoards 1 UNCTAD agencyfor ofestablishing apilot development initiatives.the importance (2009)also discusses Successfulexamples Source: Authors'elaboration basedonDevlinandMoguillansky (2011). cooperation beachieved inpractice? effective this can How (b) and sector? business the and state the between cooperation effective for ingredients essential the are What (a) tions: ques- main two answer to try module,we this in literature this of review exhaustive an provide to possible not is it While 3.3). Section (see ficiently the state to perform all its tasks effectively and ef of capacity the i.e.capacity, state of concept the to linked inevitably is debate relations. This ness state-busi- studied has literature abundant An reduce the chances of rent-seeking and corruption. bined with discipline (carrot-and-sticks) in order to the private sector, and be must state comsupport - state needs to be embedded in close relations with the relations: state-business concern clearly utes - attrib these of two money.first public The spend they forresponsiblehow them reaucratshold and bu- monitor to need the to refers accountability Finally, seek. should policy industrial that (sticks) discipline and (carrots) incentives of combination the to refers sticks” and “carrots below). expression The (see be should relations state-business close ac- how concerns countability.” Embeddedness and carrots-and-sticks, possess embeddedness, must are policy industrial that attributes design key “[t]hree v), (2008: Rodrik to According bureaucracy. transparency andevaluation, byaprofessional andsupported ing adiversity ofinterests, withwell-established for rules public-privatethe structured the useof alliances represent ofgovernment risk The capturethrough canbeminimized out. set objectives the on their impact their implementation andof of sessment effectivenessThe ofstrategies as- dependsonanobjective ing process ismanaged. the waythe industrial policymak to inwhich mately linked effectivenessThe ofprogrammes andinstruments isinti- Table 7 Principle Key policy operational ofindustrial principles - - - an adequatelyrewarded publicbureaucracy. therefore paramount,transparency asisahighlevel of and evaluationsindependent are objectives andclearapriori thisissue. to bepaid attentionso specific must The need for industrial policybyitsopponents, levelledcriticism at and Special-interestthe main the government capture is of issuewhenresourcesare animportant are scarce. independently evaluate industrial policies. costs Opportunity policyisstructured.that which to the ability emphasizesThis and, effectively, functioning isnot ifit the way rethink in withapolicy to experiment the need refers principle This to the private onboard. thus bring sector and isimperative policies late andimplement to create credibility of programmesto effectively andknowledgeofhow formu- Sufficientto bebrought funding onboard.4 external parties tive policies are collaborative ventures and require all relevant public-private consultation anddeliberation. However, selec- requireFunctional industrial may policies not extensive Evans, 1995). by introduced concept autonomy embedded the avoidto rent-seekingwith line (in corruption and the at and sufficientlybeing time order in same – from far it – challenges its understand and it the to private – sector in orderto collaborate with the right balance between being sufficiently close private sector. In doing so, the state needs to strike icy that tackle can the truly obstacles faced by the tion asymmetries and co-design an industrial pol- informa- reduce to collaboration business-state of importance the on focuses also (2004) Rodrik those ofprivate entities. than rather addressed are whole a as society of the aims the that ensure can it that so interests such by captured being resist time same the at bodies, non-governmental but it also emphasizes that the state must and sector private the with partner proactively should state the that firms of notion “embeddedautonomy”. af concept This implementation, an wasidea that captured in his and enterprises and formulation its in role a play elites economic private that is policy industrial successful for requirement crucial the that emphasizes He topic. important this to tribute con- to authors first the of one was (1995) Evans Key issues - - Industrial policy: a theoretical and practical framework to analyse and apply industrial policy 2 Empirical evidence supports this view. For ex- some initial set of institutions which over time ample, the process of industrial policymaking in the participants (or exogenous shocks) modified module the Republic of Korea saw an active government to better suit their evolving functions and politi- working in partnership with the largest family- cal circumstances.” owned industrial enterprises – the chaebol – and helping them upgrade their technologies, im- To be able to do all this, the government needs prove their products, introduce new products, to be credible – i.e. policies need to be sound and and commence with exports. At the same time, their implementation certain, and state-business efficiency was maintained by ensuring that an relations need to be based on mutual trust. One unsuccessful chaebol would lose favour and state way in which the government can show that it is support would be transferred to another chaebol credible is by phasing out support when indus- (Amsden, 1989; Chang, 1994).41 trial policies do not pay off. While mistakes are 41 Japan is also a useful possible and the government should not mini- example in this regard (John- There are several elements of state-business rela- mize risky activities (due to the entrepreneurial son, 1982; see also UNCTAD, 1994). tions – in particular information exchange, reci- nature of industrial policymaking), governments procity, credibility, and trust – that are important should minimize the costs of these failures, for for industrial policymaking (Schneider and Max- example by discontinuing support. This is also field, 1997).42 With timely information exchanges, related to the need for industrial policies to be 42 Some have also used the the government can have a better idea of the able to “renew themselves”, i.e. to change over expression “area of inter- needs and general interests of the private sector, time. This means that governments might with- vention” to refer to policy domains. as well as access data that can help evaluate pub- draw support to specific industries or firms as a lic policies. The private sector can in turn receive result of the ongoing process of industrialization, information on a number of issues that are im- reflecting the evolving needs and circumstances portant to define its investment plans (e.g. labour in which the process of discovery of new areas of market conditions, investment conditions, export (dynamic) comparative advantage occurs (Rodrik, and sectoral market prospects). 2004).

Reciprocity in state-business relations has been defined by Amsden (1989: 146) as follows: “[I]n 3 Why adopt an industrial policy? direct exchange for subsidies, the state exacts certain performance standards from firms.” This By now we know how the literature has defined means that governments should ask for perfor- industrial policy and how industrial policy can be mance improvements – for example in terms of most effectively designed and implemented. This export performance, quality standards, and pro- section aims to answer another crucial question: ductivity gains – in return for support.43 In many why do countries need an industrial policy in the 43 Export performance cases, however, governments have been unable first place? To this end, Section 3.1 reviews the his- seems to be the best indica- to monitor the implementation of such perfor- torical debate on industrial policy, focusing in par- tor of performance improve- ment, as it is the easiest to mance requirements and take appropriate action ticular on the divergent experiences of East Asian monitor. when they were not met (Evans, 1998; Lall, 2000; and Latin American economies. It looks into why Schneider and Maxfield, 1997). these economies have engaged in industrial policy and what concerns those policies have raised. This “support/performance bargain”, as Evans Based on this analysis, Sections 3.2 and 3.3 review (1998) calls it, cannot work well without two el- the most accepted arguments for and against in- ements of state-business relations identified dustrial policy. As will be noted, arguments in sup- by Schneider and Maxfield (1997), namely fluid port of industrial policy are theoretical, i.e. based communication and mutual trust between the on key economic concepts. Arguments against government and the private sector. Such com- industrial policy, on the other hand, are practical munication and trust need to be built day by in nature, i.e. they are related to how industrial day through meetings, deliberative councils, and policy has been implemented in practice. a number of ad hoc solutions that governments and business develop together in a complex and 3.1 A historical perspective lengthy process of trial and error. As Schneider (2013: 13) puts it: “[I]n most successful cases of The literature on industrial policy has found fer- business-government collaboration, it was not a tile ground for discussion in the experiences of matter of simply assembling an initial set of insti- East Asia and Latin America. As discussed in Mod- tutions and allowing a virtuous process to unfold, ule 1, in the 1950s, Latin American economies were but rather a more ad hoc and dynamic evolution better positioned than East Asian economies to where participants came together, sometimes in- catch up with the advanced world, as they pos- formally to begin with, then cooperated through sessed more developed industrial sectors than

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module order 5.2.3). (seeSection the prevailingby trade global restricted to someextent is ISI to implement policy space 5.2.1). Inaddition,the today value chains(seeSection ofglobalthe rise posed by the challenges to unsuited trade,to ISIcanbepartly 46 46 47 47 45 44 Industrial policy: a theoretical and practical framework to analyse and apply industrial policy and Turkey). (e.g. Krueger, 1974, onIndia to otherdeveloping regions (1993). comes from World Bank rogeneous results. and achievinghighlyhete- using different policymixes continent, adoptedISI, albeit countriesthe Africanmost in and Philippines Turkey and countries,the to from India War, developing most By creating barriers These critiques extended critiques These The term term The “revisionists” Afterthe Second World 76 from genuine entrepreneurs (Balassa, 1971, 1982;1971,(Balassa, entrepreneurs genuine from investments licenses,hindered import obtain to required those as procedures,such and controls bureaucraticto related excessive and paperwork delays that massive and arbitrary so was state the of interference the that argued addi- was it tion, In results. industrial unsatisfactory and allocation resource inefficient to led ultimately behaviour,rent-seekingwhich induced often ica ture of selective industrial policies in Latin Amer na- discretionary the accounts, neoclassical the on firms. Based domestic to protectionexcessive granting and prices market - function distorting thus ing, market in intervened governments where economies, American Latin in happened opposite The allocation. resource drive signals market letting thus interventions), selective er oth- or subsidies,controls, price (through prices market distorting avoided largely they that ing essentiallyat aimed “gettingright”, prices mean- policies stability.Asian macroeconomic and East political of maintenance and investments,tural infrastruc- formation, capital human through environment business favourable aimed a creating policies at industrial functional and tion interven- state limited to success Asian East the attribute tradition neoclassical the in Authors 3.1.1 evolutionaryerian economists. Schumpet (f) and economists; structuralist can - Ameri Latin (e) nexus; investment-profit the on ture on the developmental state; (d) the literature litera- the (c) Chang); Ha-Joon and Wade, Robert cnmss () “revisionists” (b) economists; neoclassical (a) by contributions and arguments main the presenting by America Latin and Asia East on literature the summarizes section This man capital andR&D. hu- as plants,equipment, well infrastructures, as spurred rapid capital accumulation in the form of effectively policies trajectories, Asian gent East as these diver behind key factors the as identified been have particular in policy industrial and cies (see Sections 2.3.3 and 3.3 of deindustrialization Module 1). Public poli- premature and to stagnation leading growth, productivity and discontinuouseconomic and modest only enjoyed hand, other countries,the American world.Latin on the in economies advanced most the joined and ized industrial - they that rapidly so capital capabilities accumulate and to managed 4.4.2) Section see NIEs; second-tier differencessubstantialwith Singapore, and Hong Kong (China) (although with China, of ProvinceKorea,Taiwan of Republic the namely economies, Asian East first-tier three decades, only in this, of spite In Asia. East in those

neoclassical The tradition 44 Aie Amsden, (Alice - - - Worldthe on Bankreport Asianmiracle”).“East the on discussion brief a for 7 Box Bank,1987;see Edwards,1988;Little industrial performances of these two regions. two these of and performances industrial economic divergent the of interpretation the to key also are (EOI) industrialization ented export-ori- of adoption Asia’s East and (ISI) tion industrializa- import-substitution America’s of Latin adoption literature, neoclassical the In thermore, wasit in that argued Latin America, ISI Fur industrialization. faster to leading not was been exhausted and it was clear that the strategy had possibilities substitution when even ISI ing implement continuedcountries American Latin interna - meeting standards.view,qualityneoclassicaltional the In of process the through and process (i.e. learning by production doing), from foreign the firms from learn and exchange, eign increasevolumes,production generate morefor to it allowed switch This EOI. on embarked and imports liberalized promptly it process, zation industriali- its in on early ISI on relied had East Asia while analyses, neoclassical to According their products. sell ciently large domestic to market which firms can suffi- a on count cannot that economies small to beneficial particularly also are strategies EOI markets,internal than rather external on cusing fo- By capabilities. and skills,knowledge, mulate production, and give firms opportunities to- accu low firms to benefit from a more efficient scale of investments,spur to employment,create alaim - tion). Together with this objective, ISI and EOI also promo- export (through exchange foreign more generating and substitution) import (through foreignexchangeof constraintssavings through balance-of-payments relaxing need: basic same the by motivated are EOI and ISI incentives. tax and credits export subsidized through achieved be can This exports. boosting by industrialize to try countries which by strategy the to refers EOI pensive andofhigherquality. ex less be to likelyeconomies, aredeveloping in which,products, foreign from competition from production by domestic firms by protecting them R&D subsidies. This policy mix aims to encourage incentives, tax innovationand incentives as such and credits subsidized as such incentives invest ment restrictions, and tariffs import as such instruments protection market of system plex com- a place in put to government the requires strategy goods. This domestic with imports trial indus - substituting by industrialize to try tries particular, ISI refers to the strategy by which coun- industrialization.In at aimed measures policy of bundles as of thought be can strategies These et al.,1970; et Wolf,1988; World 47

45 46 - - - - -

Industrial policy: a theoretical and practical framework to analyse and apply industrial policy 2 produced a bias against exports, which further domestic currency relative to foreign currencies) exacerbated the foreign exchange constraints lowered the price of domestic goods on global module faced by Latin American countries, ultimately markets, which in turn stimulated exports and contributing to the dramatic debt crisis of the economic growth. 1980s. Finally, it was noted that for an economy that heavily relies on imports – since domestic Thanks to his extensive work on Taiwan Province firms cannot provide most of the inputs needed of China, Wade (1990) has also made an impor- for production – ISI makes imports more expen- tant contribution to the debate on the role of sive, resulting in higher production costs and re- industrial policies. In his view, from the 1960s duced consumption (Krueger, 1978, 1984, 1990a; onward, Taiwan Province of China was able to Little et al., 1970). design and implement a very sophisticated industrial policy that helped the economy emerge This interpretation of the history of East Asia from poverty to become one of the most suc- and Latin America ultimately led neoclassical cessful and technologically advanced economies economists to argue against selective industrial in the world. Wade’s contribution to the theory policy. This view permeated the Washington Con- and practice of industrial policy centres around sensus and its policy prescriptions (Williamson, his claim that the state is required to “guide the 1990),48 as well as the broad pessimism with market” in building capabilities as the route to 48 The Washington regard to industrial policy that emerged in the export success, that is, to pursue a more active Consensus consisted of early 1980s.49 role in the process of economic development.50 six main policy prescriptions: (a) restricting budget deficits; (b) restricting public 3.1.2 The interpretation of the “revisionists” With the empirical evidence of the “East Asian expenditure to areas like miracle” in mind, Chang (2002) goes further back education and infrastruc- “Revisionists” strongly contested the neoclassical in history to show how virtually all of today’s ture; (c) domestic financial interpretation of the “East Asian miracle”. Their richest economies were able to develop thanks liberalization, leading to interest rates determined by work documents the role of selective industrial to what we now call an industrial policy. Chang the market; (d) competitive policies in the form of investment incentives, as shows that today’s developed countries in West- exchange rates, elimination well as domestic market protection and export ern Europe and North America utilized industrial of import restrictions, and re- promotion instruments. This strand of literature policies that allowed them to master the production of import tariffs; (e) contradicts the neoclassical interpretation in duction of many new manufactured products, privatization of state-owned enterprises; and (f) measures various aspects, most notably on the use of se- which were subsequently sold on world markets to increase competition (see lective industrial policy instruments and the late in exchange for raw materials and other non-in- Priewe, 2015). abandonment of ISI. dustrial goods. Such policies included non-tariff import barriers, subsidized inputs, and various 49 See Salazar-Xirinachs et Among the pioneering works on the nature and incentives to investments.51 al. (2014), Shapiro (2007), role of industrial policy in East Asian economies, and Wade (2015) for a review of how the perception of Alice Amsden (1989) demonstrates how the sig- With respect to the debate on ISI and EOI, revi- industrial policy changed nificant industrial success of the Republic of Korea sionists criticize the neoclassical interpretation over time. was an outcome of a (selective) industrial policy of the East Asian experience according to which that was strategically well designed, flexible, and ISI was adopted and then quickly abandoned. 50 On Taiwan Province of operationally well managed. She stresses in par- Instead, they argue that East Asian industrial China see also Amsden and ticular the success of technological upgrading in policies were particularly successful because they Chu (2003). terms of exports and in introducing clear perfor- effectively combined ISI and EOI. In this regard, mance standards for the companies benefitting Amsden (2001) coined the expression “selective 51 Some smaller countries, from state support. Related to the experience of seclusion” referring to the mix of selective inter- such as Switzerland and the the Republic of Korea, Amsden (1989) coined the ventions that created a situation by which East Netherlands, managed to develop without a comprehen- phrase “getting prices wrong”, meaning that the Asian economies were not completely open to sive industrial policy package government had deliberately attempted to dis- trade. Instead, through selective seclusion, the due to a number of unique tort market prices in order to support industri- government “filtered” foreign knowledge and compensating factors. alization. Two prices, in particular, were targeted: goods that entered the economy and created a long-term interest rates and foreign exchange complex system of incentives and discipline. By rates. Preferential long-term interest rates eased combining import substitution with export pro- the financing constraints of targeted sectors and motion, “exports are built into import substitutes firms and thus stimulated investments. These through long-range capacity planning” [emphasis selective incentives ultimately oriented the pro- by the original author] (Amsden 2001: 174). In prac- cess of structural change towards industries that tice, in the Republic of Korea and Taiwan Province maximized growth and investment opportuni- of China, this was achieved by linking ISI and EOI ties and spurred the accumulation of capabili- incentives so that exporters and their suppliers ties. A competitive real exchange rate (i.e. a cheap could obtain imported inputs and capital goods

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module Industrial Industrial policy: a theoretical and practical framework to analyse and apply industrial policy 78 strategy throughinvestment,strategy exports,higher and industrial the of success the to contributed time practice same the above-free-marketrents, This created at but leaders. market become to them allowing and power market them giving firms, these protected policy competition addition, In 1994). (UNCTAD, costs lower at and freely more institutions capable ofachievingit. and policies into commitment its translate tively effec- can and development to commits state tal private of pursuit profit.” Hence, the developmen- the and mechanism market the with compatible goals development own its make to zationally, how,organi- discover to task leadership primary of its own elite privileges, and (iii) the elite sees its perpetuation and enhancement the to foremost and first committed not is elite an such (ii) goal, underdevelopment and for whom economic growth is a fundamental and dependency of nation stag- the of breakto out committedpoliticalelite one where “(i) there is a developmentally-oriented as precisely more state development a explained dominates” (Johnson, 1982: 17). Johnson (1987: 140) state in which the developmental orientation pre- for various reasons.… Japan is a good example of a economies their in intervene states economy. All the in intervention state the of one not is issue Johnson’swords,In development. at “[t]he aimed opmental because consciouslyit and consistently devel- was state Japanese the author,the to ing one of the richest economies of the world. Accord- the role of the Japanese government in captures making Japan he which in 8), Box Japanese (see “miracle” the of analysis (1982) Johnson’s with The literature the on developmental state started 3.1.3 a ity “market areas In upon –inhumancapital formation, tor. The its market tional that While Box 7 Source: Authors. report an role, and

literatureThe on The report

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two Economic Asianeconomic andpublicpolicies growth the economists text] (World Bank, the growth industrial import sector main criticisms neoclassical

according sometimes and Thailand (Lall, 1996; Meyanathan, 1994), PeoMeyanathan,1994),- 1996;(Lall, Thailand and Indonesia, Malaysia, 1999), Woo-Cumings, 1990; 1989;Onis,1991;UNCTAD, 1996,2003;1994, Wade, (Amsden, China of TaiwanProvince and Korea Republicof the of experiences the for framework explanatory an provide to seeking others by up taken then was concept developmentalstate The 2.3. inSection described throughthe enforcement of performance criteria sector,private example the for on discipline pose im- and regulate would state developmental the employment), and investment new through (e.g. society larger the to profits redistribute to order In 2001).(Amsden, industries strategic in leaders and (d) national firm formation,creating national keeping others closed (see Sections 3.1.2 and 3.1.4); and actors foreign to seclusion”,markets some opening i.e. “selective (c) exchange; foreign ing earn- or saving, and building capabilities, firms, national management, content local (b) 4.2.1); Section (see banking core development (a) functions: four perform would the state attractive,developmental more activities manufacturing make to order In 3.1.4). Section (see investments large,the society at to its for throughexample re- prof (monopoly) their redistribute to enterprises to attract private enterprises, and it induced these made manufacturing activities profitable enough developmental state followedtwo main routes: it Japanese mission,the this accomplish to order In investment 3.1.4). nexusinSection profit-the literatureon the exporting”(see by try contributing to the economic success of the coun- time same the scarce commoditiesare at porting im- from (‘rents’) windfalls the get who “those it, puts 129) (1990: Wade As growth. productivity is

areas, – substitution andsocial, Growth and considered policy and of

namely did to revisionists, the interpretation and occurred in 1993: which more physical, so-called East (Akyüz Public important, guaranteeing 86).

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fac- in a - Industrial policy: a theoretical and practical framework to analyse and apply industrial policy 2 ple's Republic of China and Viet Nam (Studwell, states have been found in Austria and Finland 2014), and Brazil and Mexico (Schneider, 1999). (Vartiainen, 1999) and the United States (Block, module Among the developed countries developmental 2009; Block and Keller, 2011; Lazonick, 2008).

Box 8 The role of Japan’s Ministry of International Trade and Industry The Japanese economy, left devastated after 1945, was thought unable to recover swiftly. However, the first post-war Japanese government was determined to facilitate a rapid recovery and put in place a range of mechanisms to transform the economy. One of its most important moves was to establish the Ministry of International Trade and Industry (MITI), a pilot development agency with extensive powers to control the financial system and the allocation of (scarce) foreign exchange. MITI officials introduced a range of sector- based industrial policies and proved capable of arranging all of the necessary preconditions for successful establishment of firms and subsequent growth of the economy.

In the important machine tool sector, boosted by MITI’s efforts to promote R&D, targeted support was provided to specific micro- and small enterprises capable of providing sophisticated intermediate goods. Backed by generous financial assistance, Japan had overtaken the United States as the world’s leading producer in this sector by the 1980s (Amsden, 2007).

Another case is that of industrial robotics, where Japanese producers managed to edge out US-based firms to become the world’s leading producers by the 1980s. Important contributions to making this happen came from MITI and included numerous arrangements to stimulate initial demand for Japanese-made industrial robots among Japan’s small and medium-sized enterprises (SMEs) (to allow for learning by doing); significant support for R&D; and petitioning help from the Japan Development Bank (Porter, 1990). MITI has been especially active in promoting microenterprises and SMEs, which created a competitive advantage for Japan’s largest enterprises by providing them with easy access to quality and low-cost inputs (MITI, 1995).

Source: Authors.

Several observers have called for updating the Fourth, there have been objections to the classi- concept of the developmental state, reflecting cal developmental state because of its frequent the experiences of a larger range of countries authoritarian origin, as many of the successful and current challenges to industrialization and developmental states were parts of authoritar- industrial policy. UNCTAD (2009) discusses how ian regimes. The literature on democratic de- the developmental state concept can be updated velopmental states has agreed that in order to to the 21st century, identifying a number of char- build democratic developmental states, it is not acteristics that a forward-looking developmental enough to commit to a particular type of democ- state should have. First, the report discusses the ratization (e.g. holding regular elections), but increasingly important role of knowledge and in- rather it is important to harness citizen partici- novation as determinants of economic growth pation in governance and developmental issues and development, as well as the new role of (Chang, 2010; Kozul-Wright and Rayment, 2007; foreign direct investment (FDI) and global value Robinson and White, 1998). Finally, while the clas- chains (GVCs) in stimulating the accumulation of sical developmental state did not use top-down capabilities within firms in developing countries control, but rather involved careful management (see Sections 3.1.6, 4.4.2, and 5.2.1). Second, while of state-business relations, the insights from the the interventions of the classical developmen- recent studies on modern governance can influ- tal states focused on manufacturing, the report ence the conceptualization of a 21st century ver- suggests paying more attention to modern ser- sion of the developmental state. In particular, vices. Because of their learning opportunities, this literature can provide policymakers with these services could also promote diversifica- new ideas on modalities of interactions with the tion, structural transformation, and economic society (see Jessop, 1998, for the concept of “net- growth (Evans, 2008). Third, a regional approach work governance”), mixes of policy instruments to developmentalism could also help develop- (Howlett, 2004), and new approaches to improve ing countries strengthen production and trade administrative effectiveness (Evans, 2005). linkages between countries and build the conditions for structural transformation, although this According to Wade (2015), most of the roles of could also create a number of institutional chal- the classic developmental state cannot be per- lenges, especially in terms of consensus-building formed as they used to in the classical develop- and policy coordination (UNCTAD, 2007a, 2007b). mental state model, due primarily to the reduced

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module Industrial Industrial policy: a theoretical and practical framework to analyse and apply industrial policy 80 ings and provided firms with financial resources financial with firms provided and ings sav corporate boosted allowances,depreciation special and breaks tax as such incentives, fiscal particular,In investments. productive couraging en- thus opportunities, investment speculative eliminated and consumption, luxury restricted levels,free-market above profits boosted policies industrial selective of mix well-coordinated and complex a Second, climate. political macroeco- and nomic pro-investment a guaranteeing investment? at spur aimed were rents policies industrial functional these First, did how rents and create governments Asian East did How • • • three propositions: on thesis builds This andanoutcomement ofinvestment.” invest of source a investment, for incentive an simultaneously are profits investment because arise which and profits between interactions dynamic the is, that nexus; investment-profits the animating by this achieved policy ernment gov that and growth, and accumulation capital accelerating in intervention government the of role on much very depended industrialization Asian East of success the stress “that 461) (1996: Gore and 1950s.Akyüz the East in starting NIEs Asian characterized that investments and ings sav of rates high the explains 2003) 1997,2002, Gore, Akyüz and 1996; (Akyüz and profit-investment nexus the export-investmen¥t on literature The literature The 3.1.4 on ties ofGVCs. compete in knowledge- and skill-intensive - activi to policies industrial coherentof and mix large a provide to state developmental a thereforeneed low-skill GVCs,and the of for activities labour-intensive and countries low-income with pete com- and exemptions rule WTO from benefit to rich too are which countries, middle-income for important particularly is state developmental new GVCs.A of activities attracting strategically at aimed and rules (WTO) Organization Trade World with consistent II”, Mark State opmental “Devel- the as labels he de- which state, the velopment of version modern a propose to (2015) Wade led This 5.2.3). Section (see economies developing many to today available space policy ating above-free-market profits. cre- by investment accelerated Governments and investment; of source main the were Profits Asia; to fast inEast economic growth contributed greatly investment of rates High andexport-investment , 98 UCA, 94 1996, 1994, UNCTAD, 1998; al., et the profit-investment nexus

- - - - when capital and intermediate goods’ industries even challenge: one-off a not is This borrowing. to excessivealization resorting without external al- - industri of momentum the sustaining for lows expansion Export necessary. is expansion export constraints, balance-of-payments avoid without increasing external borrowing and thus imports these finance to outside order sourced In country. be the to need that goods diate interme - and capital more requires production of expansion the as imports, in increase an to goods’industries,leadtal naturallyinvestments capi- incipient with countries industrializing In export-investment nexus. to an linked also was nexus profit-investment 3.1.2). Section way,this and 2.3 alsoIn Section the licenses were subject to export performance (see import to access and protection, market mestic particular,subsidies,do- In industries. these ing nurtur in role crucial a played subsidies export and protection, market domestic services, port sup- of form the in policies industrial selective and diversification Functional automatically. economies, happen not Asian did East the advantage of comparative the with line in were industries labour-intensive although literature, of strand this to According performance. ex port with link their govern- was rents of ment-generated characteristic important Another the profit-investment iscalled ing what nexus. through incentives stimulated investment, creat rentseconomy. of the generation of The rest the productiv to linkages and strongest the enhancements,and ity economies scale learning, for potential greater with industries to allocated ly unproductive preferentialwere- towardsRent-creatingincentives uses. diverted be not would profits policy-driven these that guaranteed tal capi- of outflow the on restrictions and credits, consumer on on restrictions consumption, taxes luxury high imports, on Restrictions 1996). Gore, and (Akyüz profits decreased have would these as firms, oligopolistic large among races” capacity expansion in orderto avoid “investment coordinate to mechanisms other with together used was rationing credit example,for Japan, In and creating national leadingfirms. prices market distorting by levels market free- above profits raised further quisitions, etc.) ac- technology of screening investment,foreign on expansion, restrictions capacity of ordination managed (e.g.competitionencouragement mergers, of co- and allocation, credit on rates, Controls interest profits. corporate raising further thus productivity, and rates utilization capital enhanced investment Higher reinvested. be to - - - - Industrial policy: a theoretical and practical framework to analyse and apply industrial policy 2 are established, structural transformation is not new policy regime and its impact on productivity 52 Raúl Prebisch greatly over yet. Moving up value chains and upgrad- and the process of accumulation of capabilities, contributed to the develop- module ing technologies continues to demand techno- holding it responsible for premature deindus- ment of the United Nations system. Under his direction, logically advanced (imported) capital goods and trialization. Their studies show that import lib- the Economic Commission intermediate inputs, requiring therefore more eralization and the elimination of subsidies and on Latin America and the export expansion. other investment incentives drove domestic (less Caribbean became the most competitive) producers out of the market, also dynamic research and policy 3.1.5 The Latin American structuralist halting the processes of learning and accumula- organization in the region, developing a Latin American economists tion of capabilities initiated and sustained by ISI theory of economic develop- (Cimoli and Katz, 2003; Katz, 2000). ment and contributing to The debate about industrial policy has also been building the region. Later, informed by the writings of Latin American 3.1.6 The contribution of Schumpeterian under his direction as its first structuralist economists, particularly the Argen- or evolutionary economists Secretary-General, UNCTAD helped developing countries tinian economist Raúl Prebisch, who also served organize their initiatives as the founding Secretary-General of the United Schumpeterian or evolutionary economists also (e.g. through the G77 group) Nations Conference on Trade and Development contributed to the debate on industrial policy, and promoted a new world (UNCTAD).52 In his major work “The Economic highlighting the role of public policies in stimu- economic order with less Development of Latin America and Its Principal lating technological change and the accumula- unequal power relations between the North and the Problems” (1950), he predicates the ISI approach tion of capabilities (see Nübler, 2014; and Sec- South (Dosman, n.d.). on the ability of countries to substitute for an tion 3.1.3.3 of Module 1 for a discussion of the expanding range of manufactured imports, also contribution of the Schumpeterian economics 53 For more details on Latin incorporating technological advances and inno- school to the debate on structural transforma- American structuralism and vations into locally manufactured products.53 Ac- tion). This strand of literature conceptualizes the the theoretical reasons behind Prebisch’s support cording to Latin American structuralists, in sev- environment in which innovation occurs as an for ISI, see Section 3.1.2 in eral cases and within the right context (e.g. in the innovation system made up of firms, education Module 1. automotive industry in Brazil) ISI spurred growth and research centres, governments, and finan- in manufacturing and succeeded in raising pro- cial institutions, and forged by the interactions 54 Nelson (1993) edited ductivity and generating indigenous innovation. between these actors. Public policies constitute the first book on national However, it failed to fully substitute for foreign an important element of the innovation system, innovation systems, analys- ing a number of countries, manufactured products and did not lead to sus- as they can increase the innovation potential from the United States and tained industrialization (Katz, 1987). of each actor and facilitate interactions among Germany to the Republic of them. These two main roles of public policies are Korea, Argentina, and Brazil. The positions of Prebisch and other structural- key to maximizing opportunities for learning The book documents how ists supporting ISI were not meant to be against and for knowledge and technology transfer. countries built their innovation systems and the role of EOI: Prebisch himself encouraged combining the government in stimulat- ISI with EOI (Prebisch, 1950). Still, in practice, This idea was confirmed by a number of case ing innovation. A similar one of the central problems of Latin American studies.54 Based on the experience of East Asian endeavour was pursued by industrial policies was that they focused more economies, authors in this tradition stress that Kim and Nelson (2000), who on ISI than EOI, contributing to the balance-of- governments can play an important role in extend the analysis to industrializing countries. Over payments constraints that led to the debt cri- stimulating technological upgrading. In their time, innovation systems sis of the 1980s. Another recognized pitfall of interpretation, in East Asian economies, learn- have also been analysed at Latin American industrial policies concerns the ing and innovation did not happen automati- the regional and sectoral process of industrial policymaking. In particu- cally as a result of high investment in physical levels. In the context of NIEs lar, the lack of performance criteria and limited and human capital. Public policies, and in par- and developing countries, Malerba and Nelson (2012) state capacity to effectively implement indus- ticular industrial policies, ignited and sustained examine sectoral innovation trial policy and impose discipline on the private these processes. Industrial policy measures in systems in information and sector contributed to the limited success of ISI. East Asia were systemic, i.e. coordinated across communication technology, Little disagreement exists on this issue: limited a number of policy domains. Education poli- pharmaceuticals, and agro- state capacity and ill-suited state-business re- cies aimed to train scientists and engineers, food industries. lations are widely considered among the most infrastructure investment created a science important determinants of the divergence of in- and technology infrastructure, and various industrial policy outcomes between East Asia and centives encouraged R&D efforts within firms Latin America. (Freeman, 1987; Kim, 1992, 1997; Kim and Nelson, 2000; Lall, 2006; Lall and Teubal, 1998; Lee, 2015; ISI was ultimately abandoned in many Latin Lee and Lim, 2001). American countries under both internal and external pressure. Following the Washington Con- Based on this literature, evolutionary economists sensus, functional industrial policies replaced conclude that industrial policies should: ISI. Latin American structuralists criticized the

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module ernment’s intervention these areas, gov justifying to underinvestmentlead in 3.2, failures market would 57 57 55 Industrial policy: a theoretical and practical framework to analyse and apply industrial policy (1999). vided byKosacoff andRamos these factors isalso pro- and Pack andSaggi(2006). man, (1990), Rodrik (2004), 56 56 A concise of summary As we will see in Section seeinSection As wewill For areview, seeGross- 82 - who identifies three cases under which markets which under cases three identifies who followsthat is based mostly on Grossman (1990), • • akt alrs s extensive. is failures market and policy industrial on literature The ventions. inter government various through corrected be can failures Market missing. areor imperfect highly markets their because model neoclassical standard the transformationturalby envisioned - struc the undergo to fail that economies oping devel- of context the in exacerbated is situation outcome”efficient Saggi, (Pack 3). 2006: and This petitive market system does not yield the socially com - “a whereby failures, market of notion the on based been generally has argument cepted ac- widely most policy,the industrial an of vour fain expressed- have viewsbeen other Although infavour policy ofindustrial 3.2 Arguments structuralists Latin American evolutionary economists nexus literature, and state andprofit-investment Revisionists, developmental Neoclassical economists Source: Authors'elaboration basedonPeres (2009). andPrimi Table 8 et nevnin hud r t rdc this reduce to try should intervention ment govern- that means also This processes. tion innova - of uncertainty the to due areas, cal technologi- different in instruments policy of combinations different with Experiment examples). some for 4.4. Section (see accordingly policy mixes their change and phases these pany accom- should policies Industrial knowledge. new generationof the settings;and R&D and organizational and services, products, isting ex of adaptation imitation,engineering,and reverse- networks; and cooperation through differentways,in learn system including tion innova- the in actors other and phases. Firms different its to adapt and learning on Focus of A summary trialization. spurred byISI,to premature leading deindus- the processeshalted initiatedand oflearning trialization. Washington Consensus policies become anengineofsustainedindus- not growth, for but anumberofreasons could in somemanufacturing andproductivity industrialLatin American resulted policies technological upgrading andinnovation. towards andfostered industries dynamic (STI) spurred policies structural change these, science,technology, andinnovation Asia.the successofEast to crucial Among economies. industrial Selective were policies the industrialization processes Asian ofEast role governmentThe in played animportant distortive andwasteddistortive publicresources. industrialcause itsselective were policies trajectory be- asimilar experience did not industrialfunctional policies. LatinAmerica Asianmiracle East The wasthe outcome of Interpretation of East Asian and Latin Latin and Asian East of Interpretation 56 American industrial policies industrial American The discussion discussion The policy debate onindustrial the historical - - • below. detail infurther tion discussed promo- entry strategic and scale, of economies Economies of scale consists of static and dynamic 3.2.1 Economies ofscale cific factors that are that cific responsible them. factors for spe- to related be can these of Each perfections. economies of scale, externalities, im- and market of presence the namely efficiently, work to fail strandsthe literature of this section. reviewed in debate, policy different the of interpretations the industrial highlighting the animated have that arguments main the summarizes 8 Table 3.1.7 Summarizing order to earn a profit. Twoa of features earn related to order in goods of amount minimum a produce to need firms that is implication The increases. meaning that average output, cost declines as output of quantity the and output, of unit relationship between average cost, or cost per Static portunities. op- business new create therefore areas,and technological new exploring by uncertainty try (Mazzucato,try 2013). the to long-term vision of developmentthe counof - contribute thus and opportunities business new these exploit to sector private knowledge and networks,the and harnessing technological fields, taking risks, promising creating new new exploring entrepreneur, an economies of skills and capabilities in these industries. andcapabilities in of skills growth, andbypromotingthe accumulation externalities, andwithstrongto obstacles high potential for economies ofscale and industrialization with targeting industries by YES. industrial Selective canspur policies location ofresources. andensure andfirms industries efficient al- failures. market correct canselect market The NO.to Industrial shouldonlyaim policies Is selective industrial policy necessary? policy industrial selective Is 55 In doing so, the state becomes state the so, doing In policydebate the industrial of refer to an inverse an to refer scale 57

Industrial policy: a theoretical and practical framework to analyse and apply industrial policy 2 modern industries are relevant in this con- change. Yet, generally, market forces are in- text: large fixed entry costs, and the need for a sufficient to foster structural transformation module minimum efficient scale of production. Large and ignite inception and growth of such new fixed entry costs (e.g. due to acquisition of and more advanced industries that either do capital goods and equipment, or R&D invest- not exist yet or are not profitable. Therefore, ments required prior to production) restrict industrial policy should actively seek to sup- the number of profitable firms in a particular port and protect these economic activities industry. A minimum efficient scale of produc- that have high potential to drive economic tion is defined as that level of production that growth and technological change. The crea- allows the firm to minimize its average cost. tion of new industries outside existing com- This feature of technology limits the num- parative advantages is a complex process that ber of firms that can be competitive within may require continuous effort by the govern- a specific industry because each firm must ment, for example through investments in produce the quantity of output that is above infrastructure and development of physical this minimum efficient level of production. In and human capital as well as productive and both cases, “market failure arises because un- technological capabilities. der the given technology profitable production is not possible for private producers, and • Strategic entry promotion is an argument in the private firm neglects any positive spillo- favour of the government supporting the en- ver [in terms of lower prices] to consumers in try of domestic firms into global markets. It is making its entry decision” (Grossman, 1990: based on the notion that in some industries, 98). In such cases, there is thus a rationale for static and dynamic economies of scale and the the government to step in and subsidize firms limited size of global markets allow for profit- to reduce initial fixed costs and improve over- able production by only one firm. The strategy all efficiency of the production process. requires that a government’s commitment to support the domestic firm be credible and • Dynamic economies of scale, or learning by quick enough to deter a foreign firm from en- doing, concern cost savings made possible by tering the market. A successful intervention the accumulation of production experience produces insignificant gains for consumers in a new activity. In other words, as the firm (since costs of domestic and foreign firms, and produces more and more output, it learns hence prices, are nearly identical) but monop- and becomes more efficient, which in turn oly profits for the domestic firm and, hence, leads to a decline in the cost per unit of out- a net national welfare gain. The aerospace put. Production is likely to be unprofitable industry is a prime example of a case where during the learning period, which could pre- governments opt for strategic entry promo- vent the firm from entering the industry in tion (see Section 4.3.1, and Box 13 in particular). the first place. In the same manner as static economies of scale, there exists a rationale 3.2.2 Externalities for the government to help firms get through the initial learning period in order to subse- Externalities are defined as the benefits (in the quently become competitive. This can be the case of positive externalities) or costs (in the case case for firms in high-technology industries, of negative externalities58) experienced by a firm 58 An example of negative which work on novel and complex products as a result of actions taken by another firm. Mar- externalities is that of pollu- that require a sustained period of learning ket failures arise because the firm where the action from production where the polluting firm may not before they can use and absorb knowledge tion originates does not have adequate incentives have enough incentives to and finally be able to introduce innovations to consider the effects of its action on other firms. reduce emissions, as this in the market. The infant industry argument Thus, it may shy away from activities that are not might entail investments in (see below) can be justified on the grounds of profitable for the firm, but which provide positive new (and often more expen- dynamic economies of scale. Especially in the externalities for other economic actors (or, vice sive) machinery. In this case, the society as a whole suffers case of developing countries, this ultimately versa, undertake actions that are profitable for from the contamination that implies that on these grounds, it is possible the firm but which have a negative effect on other the polluting firm produces to justify even industrial policies that target economic actors). In sum, considering the positive and in turn may incur such industries that are not consistent with static externalities to other firms, the benefits of the costs as additional health comparative advantages (see Section 2.1.3). As investment may in fact outweigh the costs (and expenses or environmental clean-up costs that are due shown in Module 1, structural transformation vice versa, in the case of negative externalities). to the polluting firm’s ac- is a source of economic growth, and some in- tions, but that the firm does dustries are stronger than others as engines This is the case, for example, of education or infra- not consider when making of economic growth, productivity growth, structure investments. A firm may lack incentive its investment decisions. and ultimately innovation and technological to provide basic education to its workers because

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module 59 59 Industrial policy: a theoretical and practical framework to analyse and apply industrial policy growth path”.growth the as known “unbalanced the economy. of rest is This strongest linkagesthe with the promotes with industries selectively trial strategythat targeted indus- a more Hirschman, 1958)proposed Other economists (e.g. 84 • ages andcoordination failures. link and spillovers, knowledge policy: industrial of context the in externalities of sources evant rel- most two the on focus we follows, what In 1980; Stiglitz, Stiglitz, 1994). and (Atkinson projects these in underinvestment to leads ultimately This jects). pro- innovative (e.g. projects unattractive vately - pri but profitable socially evaluating when ties externali- positive account into take not would markets,banks privatecapital where in severe ly the need for intervention. This issue is particular hence externalities, positive generate that ties - activi to resources few too allocates it because fails mechanism market the scenarios, these In below byHausmannandRodrik, 2003). argument the (see process discovery the of risks and costs the incur not did that firms more for and can potentially open up new business routes riskyalsomercial is productiveareasor activities othercould firms. benefit Venturing in new com- from investing the because knowledge produced rights), erty entrepreneurs discouragedbe might prop- intellectual of absence the in (and vation projects financially attractive. In the case of inno- innovative find not might entrepreneurs vidual construction. Similarly, as we will see below, indi- its for pay not did other that competitors) by (and firms used be also could road the because market the to products its bring to road a to build lack incentive may it or firms), other efiting (consequentlyfirm leave ben- the workers might to give them incentives to create knowledge, create to incentives them give to patents) through (e.g. entrepreneurs of erty prop- intellectual protecting between ance bal- a strike to needs thus government The economy.the of rest the by knowledge of use is socially undesirable because preventsit the spillovers,however,of Prevention knowledge. of production the to desirablethan resources fewer allocate would markets knowledge, of characteristics these to Due elsewhere. ated gener knowledge other with combined if ful tarities, meaning that knowledge is more use- complemen - from benefits use Moreover,its marginally,it. only using from others prevent cannot,generatingknowledge can of costsor non-excludable, i.e. incurredthe that the firm does not diminish its original value, and often edge is non-exhaustive, i.e. its use by one firm knowl - that fact the by possible made is This it. producing of costs the incurring without knowledge some obtain might firm a overs, society.economyand - spill knowledge to Due the throughout transferknowledge of tional) Knowledge ee t te (uninten- the to refer spillovers - - - • out which goods can be produced in the country the in produced be can goods which out finding entails essentially but innovation, R&D and imply necessarily not does self-discovery advantages.comparative dynamic on This based economy their for path diversification a discover to try entrepreneurs which discovery”in process “self- (2003) a as policymaking industrialand Rodrik describe who Hausmann by identified is ventures valuable socially to in lead underinvestment externalities where instance Another multaneously. si- promoted are industries complementary where path”, growth “balanced or strategy, push” “big a for advocate to 2007) Shapiro, Nurkse,1953;Rosenstein-Rodan, also 1943;see has led some economists (Murphy ducers in need of quality input suppliers). This pro - final (e.g. industry the in firms benefit existing would which suppliers), input (e.g. it could also coordinate forsupport new firms tion of existing firms, but in the same manner coordina- facilitates government in- The volved. firms the all for outcomes beneficial in simultaneously,made result are investments the all when can, that and firms of cluster a investments in a manner that is beneficial for coordinate and in step can government the case, this In investments. these make to es) resourc- financial (and benefits enough have failures because single firms alone would not coordination generate might Markets velop. de- to linkages these for order in need made be to scale) of economies by characterized industries in (often investments multaneous Si- linkages). on discussion a for 1 Module in 3.1.2 Section (see activities economic between linkages strong of context the in relevant are Vertical knowledgeandskills).to firm-specific opposed (as knowledge general with workers their instill to requires efficiency what than less invest will firms because arises failure market consequence,the firms).a other As to moving from trained have they workers vent pre- cannot firms because (also firm single a does than it from more benefit economy the and society the because externalitiespositive argues, human capital formationto gives rise goods, such as education. As Grossman (1990) public other of characteristics of some shares knowledge as goods, public of supply the in intervention of case specific a considered be can intervenspillovers - knowledge of event the in tion government for case The actors. economic other with shared freely if society to beneficial be can knowledge that extent what to and knowledge, what judging and linkages 59

and coordination et al.,et 1989; failures Industrial policy: a theoretical and practical framework to analyse and apply industrial policy 2 at comparatively low costs. This process is gener- dustries and technological areas, government ally costly, its results are highly uncertain, and the intervention is necessary to lead the process of module social benefits of undertaking it are larger than structural transformation in these directions what would accrue to private entrepreneurs. (Cimoli et al., 2009; Mazzucato, 2015; Weiss, 2013). This would justify state intervention in this area. On these grounds, governments would support There are also learning-related reasons to reject investments in new non-traditional industries the market failure theory. Revisionists, structural- where the economy could potentially have a ists, and evolutionary economists emphasize the dynamic comparative advantage. These invest- role of learning, capabilities, and innovation for ments might also be characterized by strong structural transformation, giving governments complementarities, needing coordination and the role of catalysts of these processes. Therefore, considerable amounts of financial resources. This according to these strands of literature, stimu- would further call for government’s intervention. lating learning, the accumulation of capabilities, and innovation are considered a key justification 3.2.3 Imperfections in capital markets for government intervention (Cimoli et al., 2009; Mazzucato, 2013; Nübler, 2014; Soete, 2007). It is Imperfections in capital markets are a third set argued that market signals alone might discour- of factors that lead to market failures. They are age learning and the accumulation of capabili- essentially due to informational asymmetries. ties because, especially in developing economies, Informational asymmetries in capital markets learning opportunities might be greater in indus- arise because the borrower knows more about tries and economic activities where the economy the degree of risk and return of an investment is in significant comparative disadvantage. This than the lender does. Because of this, firms with would justify selective industrial policies and riskier projects but also a potentially higher- picking winners, because these interventions than-average return (e.g. innovative projects in could direct structural transformation towards high-tech industries) will find it difficult to access learning-intensive industries. By venturing into credit and will therefore need to accept higher these industries, governments could also explore costs of borrowing. Lenders who are aware of new business areas and create opportunities for this adverse selection will raise the interest rate other firms. Indeed, as mentioned in Section 2.1, beyond what is appropriate given the initial as- authors in these strands of literature argue that sessment. Hence, borrowers with marginally bet- instead of picking winners, many governments ter projects are excluded and the overall social create winners, becoming leading investors and benefit is therefore lower than it would be oth- entrepreneurs (Cimoli et al., 2009; Mazzucato, erwise.60 The government can address this issue 2013, 2015; Wade, 2010). 60 Beyond capital markets, by providing credit with lower interest rates and there exists a rationale for channelling financial resources into economic Learning is also at the basis of the infant indus- the government to address general information asym- activities that are perceived as too risky by the try argument. It justifies temporary support and metries. The information banking system (see Section 4.2). market protection for particular firms or indus- asymmetry problem relates tries until they become capable of producing ef- to the failure of the market 3.2.4 Arguments that go beyond market failures ficiently and surviving in international markets to equally disperse informa- (Bastable, 1927; Hamilton, 1791; Kemp, 1960; List, tion among economic actors. Economic actors function in While neoclassical economists understand mar- 1841; Mill, 1848). The argument in favour of in- a bounded reality (William- ket failure theory as the only possible justifica- fant industry protection involves several of the son, 1981) and may not know tion for industrial policy, revisionists, structural- conventional arguments discussed above. Tak- which investment opportu- ists, and evolutionary economists consider it too ing the developing country perspective, produc- nities are available (Pack and restrictive a framework. The critique of the mar- tion experience (leading to dynamic economies Saggi, 2006). In such cases, the government can intro- ket failure theory rests on its key principles. First, of scale), especially in manufacturing industries duce mechanisms that allow the neoclassical approach considers the perfectly where production size, productivity, and learning economic actors to access competitive market as the ideal market. How- are most important, provides significant cost ad- relevant information and ever, this is only one of the legitimate theories of vantages to established foreign firms. Domestic subsequently make decisions markets. Therefore, what could be a failed market firms with little or no experience are unable to based on a wider array of background information. according to neoclassical theory might be a func- accrue such knowledge and compete with the tioning market for another theory (Chang, 2003). foreign firms. In this scenario, private firms may Second, according to this theory, once the mar- be reluctant to establish new industries because ket failure is fixed, market forces will efficiently of the high risks and high costs associated with direct structural transformation towards a path entry in these new markets. Domestic markets, of economic growth and development. However, therefore, should be protected and domestic because markets cannot always drive structural firms financially supported in order for them to transformation towards the most promising in- take advantage of static and dynamic economies

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module Industrial Industrial policy: a theoretical and practical framework to analyse and apply industrial policy 86 frequent in developing economies because of a of because economies developing in frequent more and larger also are failures Government development. and growth economic on impact positive a have would hand” “invisible the ing unleash- goes, argument the consequence, a As functioning. market with more interfere ments policies, selective governi.e.- of when case the in higher are failures government of chances but policy, industrial selective and functional both of effects side as failures. arise can market failures Government fix to trying when create can governments that failures the to ure”,referring fail- “government of concept the around volves re- policy industrial against argument main The Arguments against 3.3 Ocampo, 2011, 2014). 2003; Katz, and sus- (Cimoli industrialization tained and diversification facilitating economy, the of rest the to linkages stronger and tunities oppor learning more with can industries promote particular, in policies, industrial Selective cases, role. crucial these a play can intervention government In industrialization. and growth economic sustained hindering ultimately terns, pat self-reinforcing create would advantages comparative static on based Specialization tries. indus- resource-intensive towards change - struc tural drive naturally will alone forces market economies, resource-rich in that argue turalists - struc American respect,Latin this economies.In resource-rich of case specific the to adapted be can above summarized theory failure market to critique the and argument industry infant The protection. and support of costs initial the balance would that sectors other to externalities spreads it er wheth- and support government without later stage a at survive to able is industry infant the whether predict to difficult therefore is It 2003). neity that exists between sectors (Hansen sectors between exists that neity the heteroge- of because particularly efficient, economically is intervention industry infant an whether determine to difficult develop,is fully it protection success- canhelpdomesticindustries idence showed that such temporary and support justify ISI strategies. Although some empirical ev to used been has argument industry infant The industries (Shaffaedin, infant 2000). of protection temporary for justifications main the of one represents doing, by learning trainingand through capital human of accumulation the from arising externalities and spillovers, knowledge as such externalities, internamarkets.- positive Finally,tional of realization the and regional in compete and scale of policy industrial ., al., et - - - is, oenet need governments First, these factors onebyone. discuss resources for policy implementation. We will now financial mobilize to able less corrupt,and more knowledgeable, less be to likely also are states long-debated issue of state capacity: less capable the to related are All resources. financial of lack fail- to government requirements,and corruption,informationures: lead may that identified be can factors three this, Following 11). (1990b: Krueger explains costless,” not are and corrections guardians social selfless, omniscient, not are “[G]overnments fail? governments do Why industrialsign andimplement policies. de- to governments of capacity lower generally (2014) also detail the costs of selective (especially selective costsof the alsodetail (2014) Treicheland Lin failures. government correcting and controls government enforcing of cost the as such costs, other bears also programmes. policy Industrial investment running and (SOEs) enterprises high state-owned the maintaining of to costs points (1990b) Krueger sources, the to respect with Finally, 2.3).(see Section criteria performance and monitoring through ways,of controllednumber be a can in including costs.”however,Corruption,reduce and markets expand to ways for looking than favours,rather for asking capital the in time their spend men business- and entities.Entrepreneurs connected politically to rentstransfer and competition tort dis- that benefits extract and demand to sector private the for easy becomes firms, it to support providing of business the in is government the “[o]nce it, puts 8) (2008: Rodrik As gains. sonal groups, fromcertain forelectoralper support or towin resources public use govern- may officials because ment granted for taken be cannot welfare public maximize to goal stated ment’s govern- the policy. that industrial on is view One debate the in theme recurring a is Corruption tion 2.3. Sec- in discussed sector,as private the with tion coopera- systematic more for advocate authors several shortcoming, this to solution a As 2008). 2004, Rodrik, 2006; Saggi, and (Pack sector vate - pri the than deed,less governmentsoftenknow In- operations. daily their in face entrepreneurs obstacles which and promising, more are areas technological or industries which entrepreneurs than better know should state the why clear not is it that argued been has It policies. industrial design to order in – innovation and vestments to in- obstacles firms’ and innovation, and gies technolo- trends, export and market on ample fr ex for – information lack of financial re- - - Industrial policy: a theoretical and practical framework to analyse and apply industrial policy 2 comparative-advantage-defying) industrial poli- when it comes to selective industrial policies. Lall cies: apart from the direct costs associated with (2000) and Perez and Primi (2009) argue that the module SOEs, grants, and subsidies, industrial policy also complexity of interventions and their selectivity entails implicit costs due to efficiency losses depend on the level of bureaucratic capabilities caused by the monopolies created by the state of the state. Moreover, formulation and imple- and inefficient production scales, the resulting mentation of industrial policies require public market fragmentation, and widespread support employees with good technical and administra- to domestic firms. Moreover, low or negative in- tive skills and with experience in how to best terest rates, overvalued exchange rates, price support industries and solve urgent problems. controls on raw materials, and import tariffs and This is what Salazar-Xirinachs et al. (2014) call restrictions distort market prices, increasing the “technocratic knowledge”.63 Governments with 61 On fiscal space, see UNC- costs of industrial policy. It has also been argued only basic capabilities should limit themselves TAD (2011a, 2013a, and 2014a). that public initiatives create competition to pri- to horizontal polices and venture into selective For the African case, see UNCTAD (2007b). vate initiatives (the “crowding out” argument). industrial policies only when they accumulate According to this argument, public investment more capabilities. According to Altenburg (2011), 62 For a comprehensive crowds out private investment by draining away state capacity has four dimensions: (a) the ca- review of the literature on from the market financial resources that could pability to define strategic goals and implement state capacity, including most common measure- be better utilized by the private sector (Friedman, them effectively; (b) the capability to establish ments and methodological 1978; see also Sections 4.3.1 and 4.4.3). clear rules of the game for market-based com- issues related to empirical petition; (c) the capability to deliver services ef- studies on state capacity, Most governments in the developing world have fectively; and (d) the capability to avoid political see Cingolani (2013). On how limited financial resources to guarantee basic capture. Box 9 describes several indicators that East Asian states managed to strengthen their capacity, social services like health and education and to can be used to measure these four dimensions. see Cheng et al. (1988) and implement industrial policies. Their fiscal space Although widely used, these indicators have Evans (1998). is limited by low incomes and low administrative been criticized on methodological and practical capacity to collect taxes. Moreover, globalization grounds (Arndt and Oman, 2006; Ravallion, 2010). 63 On the importance of poses additional challenges to increasing tax rev- education for the quality of enues: countries are in tax competition to attract Constraints such as weak state capacity can be governance, see Fortunato and Panizza (2015). FDI – a “race to the bottom” – and finance-driven overcome and may in fact not be the prime barri- globalization has led to the creation of a number er to introducing an industrial policy. To support of tax havens and similar settings where large this view, some scholars point out that the gov- firms and wealthy households can avoid taxes ernments of East Asia managed to initiate a suc- (Calcagno, 2015; Goedhuys et al., 2015; Guadagno, cessful industrialization process despite weak 2015b; UNCTAD, 2002). Such a limited fiscal space initial capacity. For example, until the 1960s, bu- restricts the number and type of industrial policy reaucrats from the Republic of Korea were sent instruments that the government can use.61 to Pakistan to be trained in economic policymaking. State capacity was built over time through The concept of state capacity has attracted enor- long processes of reform and experimentation, a mous attention in the literature.62 Governments difficult but not impossible task (Amsden, 1989; in many developing economies are not able to Chang, 2006, 2009; Evans, 1998; UNCTAD, 2009).64 64 UNCTAD (2009) proposes effectively implement industrial policy, especially a pragmatic approach to build state capacity in the Box 9 least developed countries. This approach is based on Measures of state capacity finding existing relevant Research in economics is often based on quantitative analysis. In order to perform such analysis, researchers practices and principles that need statistics (or economic indicators) that measure different dimensions of the economy. One of the main fit the circumstances of the country and implementing a difficulties they face in identifying the impact of institutions on the quality of industrial policymaking and small number of institu- economic development has to do with how to measure the quality of institutions. According to Altenburg tional reforms to improve (2011), state capacity and good governance can be approximated by the following perception-based indicators: the political and technical capacity of the state. (a) Strategic capability: Published every two years, the Bertelsmann Transformation Index (BTI) ranks 129 developing and transition countries according to the quality of governance, which is defined in terms of a government’s capability to define strategic goals and implement them effectively. The BTI is an aggregate of two indices: the Status Index, which evaluates the state of political transformation and the state of economic transformation; and the Management Index, which evaluates the ability of policymakers to carry out economic and political reforms. For more information see http://www.bti-project.org.

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module ments (Hobday, 2013). - experi their own undertake and requiring countriesto experiences in other contexts replicability ofsuccessful contextual,the limiting policymaking ishighly countries’ preconditions, however, given differentthat 66 66 65 65 Industrial policy: a theoretical and practical framework to analyse and apply industrial policy cier, producer, andconsumer. four roles: regulator, finan- who distinguishbetween adopted byUNIDO, 2013), Peres (2009)(also andPrimi It is worth noting, isworth It This distinction builds on builds distinction This 88 novator. in- (d) consumer; and and producer financier; (c) enabler;policy:and regulator(b) industrial (a) to main roles that the state can perform with regard dustrial policies. In doing so, distinguishes it four in- with experiences successful) less (and cessful util oiis ae okd n wih have not. which and worked have policies dustrial inwhich documenting studies case interesting produced has policy industrial on literature The 4 cy. Arduous regulatory frameworks are aconcern bureaucra- efficient an workforce,and educated vision basic of) services such as infrastructure, an privatethe pro providingby - ness supporting (or example busi- enabling and for policy, competition through functioning, market regulating means enabler and regulator a Being lor,2008). services public (Gilbert,2005;education and healthTay as such of provision the supports and facilitates that one is state society.enabling The regulatory and business for providing rules the on sets i.e. frameworks, focuses that one as Johnson (1982) characterizesthe regulatory state 4.1 amples ofsub-national industrial policies. sub-national level. the The Annex discusses characteristics and ex at implemented be also can however, policies, Industrial level. government central the at taken initiatives to relate section perceptions Capability (d)

(including Capability (c) is Index government Index, public productivity the Forum, However, independence, measure Index tend (b) Capability Authors' elaboration basedonAltenburg(2011). times. Box 9 state asregulator The andenabler policies Some casesofindustrial 65

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policies level judicial that the on of of

Industrial policy: a theoretical and practical framework to analyse and apply industrial policy 2 The example of the Republic of Korea provides a they are clearly aimed at facilitating Ethiopian number of policy lessons that could be adapted structural transformation. module to other contexts. Cheon (2014) reviews the education and training policies implemented there Apart from basic education, technical vocational between 1965 and 1995, the country’s industri- education and training is important, particularly alization period. For the sake of our discussion, for the accumulation of skills and upgrading in the most important feature of these policies technologically advanced industries. In Viet Nam, was that they were truly designed as an indus- the government has supported technical voca- trial policy, meaning that they were intended to tional education and training through the for- stimulate structural transformation. Education mulation of a strong policy framework to develop and training policies were gradually upgraded a profession-oriented education system and con- throughout the different phases of the country’s vert most existing universities into professional industrial strategy. The establishment of univer- higher education institutions. The system con- sal primary education in the 1960s was followed nects the curricula with the changing needs of by an expansion of technical and vocational the industrial and services sectors, increasingly training in the 1970s aimed at accompanying the involving firms’ representatives in the develop- heavy and chemical industry drive of the 1970s. ment of curricula and quality standards (ADB, In the 1980s, universal middle-school education 2014; UNCTAD, 2011c). and expansion of higher education set the stage for the promotion of knowledge-based indus- 4.2 The state as financier tries. The expansion of graduate programmes in the 1990s helped promote structural transforma- For a very long time, economists have worked tion towards high-tech industries. The alignment under the assumption that the financial sector with other industrial policy measures was fur- had little to do with economic growth. Beginning ther achieved through enrolment and graduate with the work of King and Levine (1993a, 1993b), quota systems, through which the government an extensive literature began to emerge demon- established how many students were allowed strating that the financial sector actually plays a in each college based on estimations of industry crucial role in promoting economic growth and needs. This policy measure was so successful that development. A functioning financial sector is by the end of the century, the Republic of Korea one that increases the quantity of finance avail- had produced among the highest proportions of able for enterprise development and ensures scientists and engineers in the world. the quality of investments through particular institutions that proactively “guide” capital into Ethiopia is currently trying to implement a simi- growth-oriented enterprises based on – and in lar approach: net enrolment in primary educa- conjunction with – an existing industrial policy tion increased from slightly more than 20 per programme. cent in 1990 to over 70 per cent in the mid-2000s. The fast growth of primary education is fueling As discussed in Section 3.2, market failures, and an increase in secondary enrolment. Technical in particular the existence of positive externali- and vocational training and higher education ties and capital market imperfections, create a are also expanding, albeit at a slower pace. Ex- discrepancy between the social and the private panding primary education at such a large scale value of certain investments, leading to under- and for such a huge population has been a major investment in projects with greater externalities challenge: from 1997 to 2013, there was a 190 per or a high risk profile (e.g. innovative projects). In cent increase in the number of primary schools evaluating projects, private financial institutions in operation, and more than 19,000 primary do not take into account potential linkages and schools were built between 1992 and 2012. Apart complementarities between industries, leading from the benefits strictly related to education, to the coordination failures discussed in Section this policy has also created jobs for teachers as 3.2.2. Externalities and capital market imperfec- well as in construction and in the production of tions call for government intervention in the fi- cement and other materials and goods needed to nancial sector. In this regard, governments can build and furnish schools (Lenhardt et al., 2015). provide resources and coordination to prioritize The Ethiopian government has also set enrol- investments in industries with the highest po- ment quotas for undergraduate studies accord- tential for externalities and the strongest linkag- ing to which 70 per cent of students should enrol es with the rest of the economy, also guarantee- in scientific and engineering faculties, and the ing minimum efficient scales. SMEs are generally remaining 30 per cent in humanities and social credit-constrained due to the capital market sciences. While these policies are creating some imperfections described in Section 3.2.3. Facilitat- concerns relating to the quality of education, ing SME access to credit helps them expand their

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module in the Middle East.the Middle in in LatinAmerica; and Turkey tina, Brazil, Chile, andMexico and inAsia;Thailand Argen- Taiwan Province ofChina, Republic ofKorea, Malaysia, of China, India, Indonesia,the the People'sinclude Republic facturing experience. These already gainedsomemanu- the endof World War II, had refersthat,to economies by ments (UNCTAD, 2015b). the declineofprivate invest offset inpart least could at their sizes,Given these banks European Investment Bank. Development Bank,the and inBrazil,(BNDES) the China and Social Development National Bankfor Economic the banksment suchas ofmanypriority develop- cyclical lendinghasbeena inet-levy. http://www.levyinstitute.org/ canbefound this project at this debate.to Outputsof has also beencontributing InnovationFinancing Project eu. INET-LevyThe Institute’s see http://www.finnov-fp7. topic.this For more details, duced interesting studieson initiative haspro(FINNOV) - Innovation andGrowth 71 71 70 69 68 Industrial policy: a theoretical and practical framework to analyse and apply industrial policy 67 67 veys.org/data. http://www.enterprisesur research. To accessdata, see www.enterprisesurveys.org/ these studies,on seehttp:// this.confirm For more details Enterprise dataset, Survey for example,the World Bank enterprises). Mittelstand (medium-sized SMEs,the to andparticularly to to channelfunds able were –ländesbankenthat – to itsregional state banks useful caseinpoint,thanks Republic ofGermany isa projects. then Federal The of industrial development financing direct undertaken development banks have also Regional andlocal state Empirical studiesusing, “Late industrializers” The EuropeanThe Financing In recent years, counter- 90 - - n lot l scesu srcua transforma- structural successful all almost in policy industrial implementing in role major a played they post-warperiod,the fections. During imper these address to aim banks Development TAD,2014b). 2007b, - (UNC markets new enter and competitiveness, their grow, to boost firms’ chances local limiting capital, available of scarcity a to contributes tor sec- financial underdeveloped An countries. ing develop- in investment to obstacles major of the one as cited often are constraints Financial 4.2.1 Development venture capital andloanfunds. economies:industrializedstate effectivein be to proved has that instrument policy advanced ly developmentbanks, support,SME relative a and - important in this domain. This section focuses on arrangements, and policy instruments have been institutional institutions, Various programmes. formally registered to have access to government be to required are firms as businesses, of zation SME Moreover, schemes support can be a vehicle people.for the formali- more employ and tive produc- more become therefore businesses,and and newbusinessopportunities. innovative and risk-taking firms thatcreate value most the as understood firms, worthy most the reward not do and economy real the invest in ments promote not do sectors financial their beit of a different nature. It has been argued that markets,al- capital in imperfections from suffer banks 67 Developed economies also economies Developed 68

- - cato and Penna, 2014). (Mazzu- projects to innovative most the access for credit facilitating and investment private low of periods in investmentsrole,guaranteeing entrepreneurial and counter-cyclical damental recovery (Weiss, 1998). Today, KfW still plays a fun- to backing upfinance an industrial-policy-driven für provid- in valuable proved KfW) (Kreditanstalt – Wiederaufbau Corporation Loan struction Recon- state’s the where Germany, of Republic Federal then the of that is experience European tion experiences (Amsden, 2001). telling The most Korea and Brazil (see Box 10). Box (see Brazil and Korea of Republic the of examples early the as well as the of all industrializers”, “late virtually of success development industrial development the behind state were banks that finds (2001) Amsden infrastructure asupportive build (Johnson, 1982). to and shipbuilding, vehicles,electronics,and tor based on capital-intensive industries such as mo- velopment banks to underpin an industrial policy or shipping(Chandrasekhar, 2015). power as such industries particular to restricted were mandates whose institutions financial ized special- several creating strategy: different a for Republic of Korea, other countries like India opted trial policy objectives. In contrastto Brazil the and the be to government’sinstructed support indus- also could that banks state-owned other various alongside operatedgoals. KDB policy The dustrial Korea Development Bank (KDB) – to support its in- the –notably institutions financing established Korea, the state controlled the financial sector and 69 Japan,too, used state de- 70 In the Republic of of Republic the In 71 Industrial policy: a theoretical and practical framework to analyse and apply industrial policy

Box 10 2 Measures of state capacity A textbook example of a large and influential development bank is Brazil’s National Bank for Economic and module Social Development (Banco Nacional de Desenvolvimento Econômico e Social – BNDES). Established in 1951, BNDES greatly contributed to the ISI strategy implemented during the post-war period and the EOI strategy implemented since the 1970s. Benefiting from its close relationship with the government and strategies to guarantee an ever-increasing flow of resources, BNDES was able to specialize in the provision of medium- and long-term financing to projects in the industries targeted by the government (i.e. non-ferrous metals, chemicals and petrochemicals, paper, and machinery and equipment).

Lending activities have always been concentrated: in the 1950s, chemicals and petrochemicals accounted for 35.7 per cent of BNDES loans to manufacturing, and the metallurgical industry accounted for 34.5 per cent (Guadagno, 2015a). In 2012, two-fifths of BNDES loans were allocated to its five top borrowers, among them Petrobras, the state-controlled oil company (Chandrasekhar, 2015). Priority was given to projects directed towards acquiring (national) capital goods and equipment, a cornerstone of Brazil’s ISI strategy. To this end, in 1964, BNDES launched the Financing of Machinery and Equipment Programme (Financiamento de máquinas e equipamentos – FINAME). In the years that followed, similar programmes were launched in other NIEs such as the Republic of Korea and Mexico. In the mid-1970s, FINAME loans accounted for 1.5 per cent of Brazilian GDP (Guadagno, 2015a) and by 2013, for more than 3 per cent (Guadagno, 2016).

BNDES succeeded in helping establish a steel industry and make Brazil a major exporter of steel. The automobile industry also greatly benefited from BNDES activities. Thanks to careful oversight of its clients, BNDES was able to ensure that its loan facilities leveraged important technological benefits for the companies and, more importantly, for the local communities or industries in which they operated. One of its most famous successes – the aircraft manufacturer Embraer – was assisted in finding an important niche in the global aircraft sector. Through its offices across Brazil, BNDES also supports the SME sector, providing loans to promising SMEs and, even more importantly, attaching “local content agreements” to loans to big companies.

In the 2000s, BNDES expanded its foreign operations, supporting regional economic integration and investment promotion in neighbouring countries, strengthening links between Brazil and other developing regions (particularly Africa), and supporting the internationalization of Brazilian firms. In 2014, 14 per cent of BNDES loans were in foreign currency (UNCTAD, 2015c). Finally, since the 2007–2008 financial crisis, BNDES has played a counter-cyclical role in the economy, stimulating investments to reverse the economic downturn.

Source: Authors’ elaboration based on Amsden (2007), Chandrasekhar (2015), Ferraz et al. (2014), Guadagno (2015a, 2016), and UNCTAD (2015c).

What do the development banks do? Their role in society or are carried out in rural areas). Apart industrial policy programmes is fairly straight- from credits, which are by far the most impor- 72 Whatever sources of forward: they are the financial arm of the state, tant instrument, development banks also pro- funding they rely on should “mandated to provide credit at terms that ren- vide equity investments, grants, trade finance, have a medium-to-long-term maturity; only in this way der industrial and infrastructure investment technical support, venture capital, and other can they match the maturity viable” (Chandrasekhar, 2015: 23). Development financial instruments tailored to the needs of of the credits that they pro- banks are in direct contact with, or are super- micro and small enterprises, such as mezzanine vide, thereby guaranteeing vised by, ministries or other government bodies, financing, convertible financing, and subordi- matching maturity of assets fostering cooperation and ensuring policy co- nated equity.73 Development banks also need and liabilities. herence. They mobilize resources either domes- to monitor the activities of the firms to which tically or internationally through government they lend, sometimes by nominating directors of 73 See Guadagno (2016) funds, official development assistance, bonds, their boards. for a description of these and fiscal revenues.72 Once resources are mobi- instruments. lized, development banks invest these resources How can we quantify the size of development in industrial and infrastructure projects. They banks? One indicator to measure development 74 These are based on publi- design and manage credit lines with subsidized banks’ activities is the share of development bank cly available data published interest rates, evaluating the developmental loans in GDP.74 Figure 26 depicts the enormous in banks’ annual reports and financial statements. Depen- impact of the projects that seek financing and resources channelled through BNDES and KDB ding on the details provided selecting projects that are more strategic and/ between the 1960s and the 1980s. It also shows by the bank, the researcher or in line with government industrial plans (e.g. the gap in lending between these two banks: KDB can also verify how impor- projects that aim to increase firms’ competitive- invested between 4.5 and 8 per cent of GDP of the tant certain manufacturing ness or projects with a high social value, such as Republic of Korea; BNDES invested between 0.9 industries are in the bank’s loan portfolio. those that help marginalized segments of the and 3.4 of Brazilian GDP. To put these numbers in

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module Indicators (WDI). Bank's World Development 75 75 Industrial policy: a theoretical and practical framework to analyse and apply industrial policy Figuresthe from World 92 the Republic of Korea spent 2.2 per cent of its GNP perspective,mid-1970s,the in governmentthe of l' Rpbi o Cia a as be under been also has China of Republic ple's Peo- the of success industrial recently,the More these out” cerned international large infrastructure investments inAsia. ers. The orothercommodities by supplyingoil CDB CDB ing support cated BNDES culture, standing could Chinese and Bank Established Note: BNDES: National Bankfor Economic andSocial Development, Brazil; KDB: Korea Development Bank. Source: Authors'elaboration basedon Table inGuadagno(2015a: 4.14 106). Source: Authors'elaboration basedonChandrasekhar (2015), Guadagno(2016), SandersonandForsythe (2013), andUNCTAD (2015c). China, by project, US$267 billion, Today Figure 26 Box 11 lending

These industries bank the

loans strategy (Sanderson deals borrow to

the providing in vendor

contacts mobilizing manufacturing, GDP to Chinese experience also credits Brazil, CDB (Sanderson firms to might in 6.0 9.0 0. 4. 8.0 5. 2.0 3.0 7. 1.0 (Guadagno, in customers to 0 0 0 0 local such roughly equalling 22percent owns financing 1994, is

order starting nine help that roughly investments allow and huge:

role of The also government funds as

Development an in 1965–1970 the

the Chinese times Forsythe, to telecommunications, and have the

evaluating in equity

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the infrastructure former and was 1975–1980 these markets.

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of fields, is US$991 by the bank(UNCTAD,

consist These the the Korea, fifth

energy, providing and In mainly currency and 75 that (percent) 1960–1990

Development recent Chinese contributed the the

this largest loans

quasi-equity and billion, through of

“going out” lending and

buyers CADF expansion

1980

loans supporting the area, involve

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infrastructure, provided 2015c). benefit Fund

strategy bulk to pay of investments double

than the This in the these

provincial

important strategy phases for the a back (CADF), Chinese of was to new close government’s

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times which activities

their and

governments but urbanization 12 manufactur of CDB loans half Republic CDB’s per the

also technical achieved

involved projects, those Some totalled is of cent “going World to long- dedi- - agri total buy con- the

of of of of - -

Industrial policy: a theoretical and practical framework to analyse and apply industrial policy 2 What is the size of the loan portfolio of the most between 0.1 and 11.7 per cent of their countries’ active development banks today? Guadagno GDP on loans. Despite the lower incomes of Viet module (2016) analyses the experience of eight influ- Nam and Ethiopia, their development banks are ential development banks: the Hungarian De- very active, devoting (mostly industrial) credits velopment Bank (MFB), Brazil’s BNDES, China’s amounting to 7.5 and 1.7 per cent, respectively, of CDB, the South African Industrial Development their countries’ GDP. The figure also shows how Corporation (IDC), the Industrial Development large the loan portfolios of BNDES and CDB are, Bank of Turkey (TSKB), the Small Industries De- representing 10.4 of Brazilian GDP and 11.7 per velopment Bank of India (SIDBI), the Viet Nam cent of Chinese GDP, respectively. As a bench- Development Bank (VDB), and the Development mark, in 2012, the Chinese and Brazilian govern- Bank of Ethiopia (DBE). Figure 27 shows the share ments spent 3 and 4.5 per cent of their respective of their loans in GDP in 2012. These banks spent GDPs on public health.76 76 Data from the World Bank’s World Development Figure 27 Indicators. Development bank lending as a share of GDP, 2012 (per cent)

12 11.7 10.4 10

8 7.5

1.7 2 1.1 0.50.5 0.1 0 SIDBIIDC TSKB MFB DBE VDB BNDES CDB

Source: Authors' elaboration based on Guadagno (2016). Notes: SIDBI: Small Industries Development Bank of India; IDC: South African Industrial Development Corporation; TSKB: In- dustrial Development Bank of Turkey; MFB: Hungarian Development Bank; DBE: Development Bank of Ethiopia; VDB: Viet Nam Development Bank; BNDES: National Bank for Economic and Social Development, Brazil; CDB: China Development Bank.

Guadagno (2016) also shows that these devel- and the ten major banks operating in Brazil in opment banks address a market failure in the 2012. The vast majority of loans by those Brazilian economy because they provide a type of “patient banks have a maturity of less than three years; capital” (i.e. medium- and long-term credits) that the opposite occurs in BNDES, with 75 per cent of private banks only provide in rationed quanti- the loans having a maturity of more than three ties. Patient capital allows firms to undertake years. If we look at loans with the longest matu- long-term industrial projects, for example to ex- rity (more than 15 years), BNDES outperforms the pand, modernize, or diversify production. Figure other major banks with 9.2 per cent against 1.9 28 shows average maturities of loans by BNDES per cent of these loans in its portfolio.

Figure 28 Average maturities of BNDES loans compared to maturities of major banks in Brazil, 2012 (per cent)

Up to 3 years BNDES 10 Major banks in Brazil Between 3 and 5 years Between 5 and 15 years 2 9 11 More than 15 years

35 12

20 75

Source: Portugal (2013). Note: BNDES: National Bank for Economic and Social Development, Brazil.

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module 77 77 Industrial policy: a theoretical and practical framework to analyse and apply industrial policy al. (2005). For more details, seeHuet 94 4.2.2 Support h sces f ay nepie development enterprise many of success the means,any by science perfect a not is terprises the While identification of such en- high-impact the useofhighly-skilled labour.and potential, export of innovate,fostering to ability technologies, key of deployment and/or eration gen- via achieved economy.be could impact This the on impact largest the make to potential est muppets, not gazelles, but high- havethe they as industrialthat policy should focus on supporting (1994), is Storey following much mendation,very might be seen as another policy fad.” Their recom- entrepreneurial start-ups, no matter their quality, out that “[a]cross the board policy enthusiasm for a few years. Nightingale and Coad (2014: 136) point the majority of which would exit the market after involvethe entry of large numbers of enterprises, would – entrya “scatter-gun”new – to approach them improve and expand. The alternative to this helping on resources focus above,and described SMEs innovative “gazelles”,identify the to try to innovation. is policymakersfor industrial key The and upgrading technology through turalchange only a few new SMEs that gave impetus for - struc industrial policy. Storey (1994) showed that it was of success the to crucial be to proved has SMEs industrial new of entry countries, advanced In Silicon Valley inCalifornia. the locations,severalin notably in provided they account of the growth and development impetus retrospective justification in the United States on huge given institutes.Spin-offswereresearch or universities, corporations, large leaving gineers en- or managers entrepreneurial by created firm spin-off,small the a is SMEs of type particular A or adopt develop new breakthrough innovations. to keener are they profits, generate they which from process or product specific any into locked not are they since history: prior of lack their by blessed innovation.also and areSMEs tivity New crea- for allow that structures bureaucratic with less organization, agile their to thanks prises enter larger over advantage an have can latter “gazelles”. The call they which SMEs, innovative highly and early-stage or “muppets”, call (2014) Coad and Nightingale which SMEs, productivity Schumpeter, 1942). SMEs can be of two types: 1971; under-sized, low- Galbraith, 1990; Audretsch, and (Acs it to contribute also can SMEs as tion innova- of source meaningful only the not are econo- of corporations industrial large that claimed number mists a onward, 1940s the From

medium-sized enterprises for and small - oal i eetois se lo eto 4.4.1). Section also (see electronics in notably most them, of number a off spinning SMEs,cal lo- with extensively cooperated Research (ITRI) TechnologyInstitute Industrial public the such as organizations Other 2001). Amsden, see spending; R&D total of cent per 17.5 and China of Taiwanof Province output of cent per 4.2 for accounted 1995 in tenants whose Park, Hsinchu Science the (notably parks science including SMEs, these support to founded were izations 1960, After numerous technology development 1990). organ- Wade, 1996; (Lall, new SMEs high-tech supporting at aimed programme policy industrial determined very a on relied China of Province Taiwan example, For enterprises. local other into and through value acquired of forms equipment,labour,knowledge, skilled other and recycleto capitalthe recombineexists and bility enterprises high-impact afterlaunch,quickly possi- quite the down close such when cases in Moreover,even them. with run and enterprises high-impact likely most the identify to possible indeed is it that well,suggest as would industry capital venture private the of programmes,and World Bank, 2015). (Lenhardt markets credit access SMEs scheme offered helps the government further by guarantee credit partial the regard, a this In loan. obtain to required rates collateral high larly - particu the to due mainly is This lending. total of cent per 7 only for Africa,accountingSaharan sub- in lowest the among is Ethiopia in lending overall in lending SME of share the 2015), Bank, (World estimates some to According finance. of (see Box 12 for a short discussion), namely the lack missing-middle phenomenon facingthe country the of determinants key of one tackling is ment govern- the way, this In employment. informal of reduction consequent the and formalization with financial support, thus contributing to their them providing by enterprises small and micro support to programme a implemented has ple, exam - their for government, Ethiopian support The to growth. policies implemented have governments many this, to Due areas. rural in especially population, the of portions large for incomes and jobs of source only the represent often they that means also This countries. such in production industrial of bulk the constitute generally firms nature,these informaloften and productivity low their predomi- Despite muppets. are nantly SMEs economies, developing In and otherdiscount schemes(Wade, 1990). purchases local assisted and orders state with scales efficient minimum achieve them help to order in support received also SMEs Early-stage et al. , 2015;et 77

Industrial policy: a theoretical and practical framework to analyse and apply industrial policy

Box 12 2 The “missing middle” phenomenon The expression “missing middle” refers to a crucial characteristic of productive structures of many African module economies. These structures are typically composed of a myriad of micro and small enterprises, with only a few large enterprises and far fewer medium-sized enterprises. Large firms are generally capital-intensive, resource-based, import-dependent, or assembly-oriented, and are often affiliates of foreign firms or SOEs. Micro and small firms employ considerable portions of the workforce, but have low productivity levels, use basic technologies, and are generally informal. This creates a productivity divide between large and small firms, contributing to the structural heterogeneity described in Module 1 of this teaching material. Empirical research in this area has shown that the main obstacles to firms’ growth in these economies include lack of finance, family-dominated ownership structures, and entrepreneurs’ preferences to remain small and avoid formalization (Iacovone et al., 2014; UNCTAD, 2001). Apart from facilitating access to finance, governments can initiate the creation of linkages and networks between more and less productive firms (Kauffmann, 2005; UNCTAD, 2006a).

Source: Authors.

4.2.3 State venture capital and loan funds inputs and R&D activity in relation to its mobile phone operations (Breznitz and Ornston, 2013). At higher income levels, state venture capital funds have proved to be important contributors The other institution of note here is Finland’s to industrial policy programmes, supporting in- development agency, TEKES, the Finnish Funding novations that could be commercialized by local Agency for Technology and Innovation. TEKES also companies. For example, Ireland’s development provides large sums of capital to underpin early- agency, “Enterprise Ireland”, has been a pioneer stage innovative SMEs. By 2000, it enjoyed a budg- in using its own venture capital fund to sup- et of roughly 400 million euros to support R&D port export-oriented innovative enterprises. The activities and in general the drive to establish a success of Enterprise Ireland’s equity stakes in a knowledge-based economy. TEKES-supported number of high-technology start-ups has been SMEs could also link into the growing capacity of shown to have provided a major fillip to local in- Nokia, not least because TEKES was also responsi- dustrial development and plans to reorient Ire- ble for co-financing the software protocol for the land’s economy away from traditional industries GSM digital mobile communications standard (Barry and Topa, 2006). In Israel, the Office of the that launched Nokia on to the world stage. Chief Scientist financed investments in many new technologies and created an industrial net- 4.3 The state as producer and consumer work that is said to be one of the world’s best examples (Breznitz and Ornston, 2013). The role of the state as producer is probably the most controversial in the literature. States have Another country that very creatively used the often decided to directly produce goods or tech- state venture capital model is Finland. A low- nologies that they deem strategic for the indus- technology-based economy until quite recently, trial development of their economies. In certain Finland has enjoyed remarkable success thanks industries, minimum efficient scales of produc- to a range of industrial policy programmes, and tion require firms to make huge fixed capital especially thanks to a number of public venture investments, with all the risks associated with capital funds. Two such funds in particular have such investments. Especially if the state consid- played a decisive role in facilitating innovation- ers an industry particularly strategic, it might led structural transformation. The first, and by see it as beneficial to invest in it by setting up some accounts the most dynamic, is SITRA, the public enterprises (SOEs). The state can also act Finnish National Fund for Research and Develop- as a consumer through public procurement. In ment. Established in 1967 as a state investment this area, state intervention can be justified on fund that operated as part of the Bank of Finland, the grounds of externalities: by procuring goods SITRA was tasked with promoting innovation in characterized by high externalities (e.g. infra- SMEs. By taking equity stakes in early-stage inno- structure, education and health, science and in- vative SMEs, and by supporting a range of other novation), governments can re-establish the so- venture capital funds, SITRA was able to leverage cially desirable rate of investment in those areas. large amounts of capital into innovation indus- Public procurement can also be justified by the tries. A noted contribution was SITRA’s support to promotion of strategic entry, for example in the develop a local high-tech SME network that Nokia case of defence procurement. We will now dis- was later to rely heavily upon for highly specific cuss these two policy instruments one by one.

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module paramount. minimum efficient scales are economies ofscale and intensive where industries are all large-scale capital- 78 78 Industrial policy: a theoretical and practical framework to analyse and apply industrial policy Steel, oil, andaerospace 96 and investmentstechnologies. instate-of-the-art raise R&D increase efficiencyto and orderin ship owner public by displaced were enterprisesvate Kingdom in the same period, under-investing - pri United the In industries. heavy into innovations lead in transferring technologies and introducing the took SOEs example, for France, and Austria post-war In example). an for 13 Box (see projects development industrial major to linked are ties - activi their if play,especially can SOEs that role the with unfamiliar not is den,2001:214).Europe (Ams - industry” private entered later who neurs entrepre- and staff technical a for ground training became and R&D, in invested management, professional “strengthened they as crucial also were SOEs 2007).(Amsden, upgrading industrial the at vanguard of structural transformation and burden to the state, in other cases they have been SOEshave aggravated deficits,public a becoming times at fer. while that shows evidence Empirical as engines of technology development and trans- SOEshave cases some acted in that noted Others and World Bank, 1995). 1999;Shirley, Shleifer,1998; 1984; Floyd, also see al.; 1980; Niskanen, 1971; Shleifer and Vishny, 1994; Buchanan 2000; (Bennedsen, maximization profit pursue than interests,rathernational low fol- they because inefficient are SOEs that gued ar was favouritism.Moreover, it and corruption to leading objectives, conflicting to subject be also might officials SOEs,government operating in Indeed, businesses. running in governments than better perform would who entrepreneurs private to credit of portions excessive subtract they crowd private out that investments, i.e.they is enterprises public against argument Another 1986). Hart, and Grossman 1972; Demsetz, and mately reduces incentives to be efficient (Alchian translates into a lack of self-discipline, competition which ulti- of lack This takeovers. threatened external by not are managers firms, public of assets the for market a of absence the In tions). of opera- end the at benefits claim can one no (as profits generating firm the in interest clear a clear residual claimant, meaning that no no one has have enterprises public that is argued, was it inefficiency, ofsuch cause main The ficiency. inef andtheir countries, developing fiscal of deficits the aggravate which costs, high their of tradition,SOEsbecause of use havethe criticized erature.observers,Some neoliberal the in mostly lit the in views opposing generated have that SOEs are one of the industrial policy instruments 4.3.1 enterprises State-owned et et - - - - reach the speedof500km/hour.reach could that train produced domestically entirely ther,the development of an to which led in 2009 nologies used by the TNCs and improve them tech- fur the absorb and import to able were SOEs years, few a of matter a country. In the in jects pro- innovative start to incentives enough have firms, local not by did skills TNCs and knowledge of accumulation country and absorption facilitated the had in presence their Although innovations. breakthrough develop to (TNCs) tions corpora- transnational on rely not could it that In this industry, the Chinese government realized 320). 2014:Wu, and SOEs” (Lo the are technology frontier of development the where for vehicles industry, “main railway high-speed the from comes SOEs Chinese of role the of example tive strategic nature of state investments. An illustra- the reflecting capital-intensive, and large-scale (Loand 2010 in Wu,2014). SOEsChinese are Most cent per 38 reaching 2000s, the since increased steadily has it 1990s, the of reforms the of sult re- a as decreased SOEs by for accounted share value-added the policy:while industrial Chinese of cornerstone a been also has ownership State private (Vrolijk, firms forthcoming). werethat later adopted and advancedfurther by (1974–1991),technologies SOEs developed certain Council Administrative Military Provisional the (Guadagno, 2015b). InEthiopia, of the rule during industry pharmaceutical the in capacity duction pro- create to order in Limited, Pharmaceuticals dustan Antibiotics Limited and Indian Drugs and Hin- SOEs, two established government the ple, exam- for India, in levels income lower At 2001). (Amsden, plants petrochemical for equipment and engineering of field the in knowledge and with traineda workforce, professional managers, them providing by firms local benefited greatly SOEs by undertaken investments capital human stein, 2002). stein, na, respectively, as well as Embraer in Brazil (Gold- pany, the oil companies of Mexico, Brazil, and Chi- PEMEX, Petrobras, and the China Petroleum Com - are experiences successful Other and 1996). Ferme, Sohal 1989; (Amsden, 1968 in established Company Steel and Iron Pohang the POSCO, of and Grabel, 2004). This was, for instance, the case 2002;Chang,1994;also Chang (Chang, see SOE a were not up to the task, the state regularly set up terprises (chaebols), whenever private enterprises en- owned privately with cooperation in forged largely was experience policy industrial Korea’s of Republic the while that reports (1994) Chang 78 Spillovers from technological and technological from Spillovers - Industrial policy: a theoretical and practical framework to analyse and apply industrial policy

Box 13 2 Airbus as an example of the positive role of state-owned enterprises in industrial policy Once a market sector dominated by US-based companies, aircraft manufacturing requires massive resources, module perfecting and going beyond state-of-the-art technologies, an innovative mindset that encourages experimentation, and a solid network of SMEs producing to extremely high tolerances. For political, security, and economic reasons, the European Union set a goal of establishing an aircraft industry capable of competing with the aircraft corporations based in the United States. Consequently, the Airbus Corporation was founded in 1970 by a consortium initially composed of France, Germany, the United Kingdom, and the Netherlands. Air- bus pioneered forms of cross-border knowledge and information-sharing that would have been impossible without the mediating presence of the various states. It pioneered new technologies such as those in the field of carbon composites and fly-by-wire technologies. Finally, it developed a strong network of subcontractors that received technical support from the head office and affiliates. Extensive and consistent state support was provided by all consortium members in order to get the Airbus project into operation. Scholars assessed the impact of Airbus in positive terms, pointing to positive technological externalities benefiting other economic activities (Neven and Seabright, 1995).

Source: Authors.

SOEs can also play an important role in fulfilling ficult to achieve due to globalization and GVCs. an industrial policy mandate at the regional or Privately-owned enterprises are far more likely to local level, as shown in the case of Medellin, Co- abandon the local community and local subcon- lombia (Box 14). In particular, the willingness and tracting chains than are local public enterprises, ability of an enterprise to support a local network which generally imbibe strategic goals other of subcontracting SMEs is a valuable asset for the than simply profit maximization (McDonald and community, but one that has become more dif- Ruiters, 2012).

Box 14 The role of state-owned enterprises in local development: The case of Medellin Empresas Publicas de Medellín (EPM), established by the regional municipality of Medellín, Colombia, has played a central role in spurring economic growth depressed since the 1980s. Thanks to its contribution, Medellín was voted in 2014 the world’s most innovative city owing to its progress in urban development, social inclusion, and the creative use of technologies. EPM has also helped implement an industrial policy. By channeling around 30 per cent of its revenues into economic and social development programmes, it has contributed to the technological upgrading of the city, relaxing the budget constraints faced by most other Colombian cities. The Medellín Cluster City Programme, a major business incubation programme, was established and funded by EPM. The programme involves six strategic clusters in electric power; textiles, apparel and fashion design; construction; tourism; medical and dental services; and information and communication communications technology (ICT). In addition, its fluid relationships with local SMEs and subcontractors facilitate knowledge and technology transfer, improving the quality of goods and services by subcontractors, and maximizing its impact on the local economy.

Source: Authors' elaboration based on Bateman et al. (2011).

Despite the evidence of these successes, history a sugar milling monopoly established in Bang- is replete with cases of inefficient SOEs. Some ladesh, the government required farmers to sell cases can help to illustrate the mistakes that sugar cane at below-market prices. This induced government can make in establishing and run- farmers to plant other crops, creating a shortage ning SOEs. Inefficiently managed SOEs can lead of sugar cane and a consequent increase in sugar to capacity underutilization and financial losses, prices (World Bank, 1995). culminating in bankruptcy, as was the case of many African SOEs (e.g. the Tanzanian Morogoro 4.3.2 Public procurement shoe factory, which was created to boost exports but never operated at more than 4 per cent of Through public procurement, governments and its installed capacity; see Easterly, 2001). Lack state agencies procure goods and services for of managerial skills can delay production and their own use, guaranteeing sufficient demand. create inefficiencies in daily operations, as hap- By setting standards and technical characteristics pened in the early history of the Altos Hornos, the that the procured good must have, governments steel mill established in Mexico in the early 1940s can also spur technological change and act as (Amsden, 2001). Conflicting interests can create knowledgeable consumers with which firms can conflicting incentives: for example, in the case of interact and cooperate. Clearly, this policy instru-

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module (2015), and (2015). WIPO al.(2015),Hoeren et Mowery these experiences, see 79 79 Industrial policy: a theoretical and practical framework to analyse and apply industrial policy For arecent review of 98 for publichealth expenditures (Farla, al. et 2015). amounts the GDP,Union’sdouble European the of cent per 16 roughly for accounts it that dicate in- Europe,estimates in recentrole where crucial in aeronautics.in cessful innovations and investments, for example suc- to led also strategies Similar procured. they cal characteristics and requirements of the goods nological efforts of firms by specifying the techni- military agencies the directed scientific tech- and its and government US the industries,where tor semiconduc - and computer the fromcome ment procure- public effective of examples Textbook task.this to perform knowledge andcapabilities technical necessary the possess agencies, state yet, better or governments, that requires ment edge base on which firms can build to produce to build can firms which on base edge science policies governments can create a throughknowl- particular, In policies). differences these the between of discussion a for 16 Box (see firms’ ring investments through R&D policies STI spur in and technology, and science advancing in role catalytic fundamental a play can policies Empirical evidence has demonstrated that public underinvestmentthese areas. in to linkages,leading and spillovers knowledge of form the in externalities significant by acterized char are innovation and production knowledge more makeprojectsor expensive.such it Second, to credit deny consequently and projects vative ofinno- quality the to evaluate difficult it find lenders activities, innovative of nature certain un- highly the and market capital the in metries - asym information to due grounds.First, justified two on be can innovation spur to tervention in- Government 1). Module (see dustrialization in- of determinant important an is Innovation The4.4 state asinnovator transfer offset above inputs, are generally onerous, domestic in ment (formally procurement. These Source: Authors'elaboration basedonGuadagno(2015b). In Box 15 Indian order

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Industrial policy: a theoretical and practical framework to analyse and apply industrial policy 2 novation systems of various successful countries. nism of technology transfer that has received Publicly available knowledge can create a knowl- most of the attention in the literature. In the do- module edge base and form a pool of experts who can main of innovation policies, R&D subsidies are benefit private firms through spin-offs, consortia, gaining importance in countries’ development and other forms of cooperation. In the domain of and innovation strategies. technology policies, FDI attraction is the mecha-

Box 16 Defining science, technology, and innovation policy This box outlines the differences between STI policies (see Table 16.1). In doing so, it adopts a systemic approach to innovation, making a broad range of actors responsible for the innovative performance of the economy (see Section 3.1.6 in the main text). Following this approach, the instruments of STI policy include measures to stimulate the supply and demand side of technology and innovation, strengthen the performance of the actors of the innovation system and the relationships among them, and address framework conditions for innovation.

Table 16.1 Defining science, technology, and innovation policy Focus Examples of instruments used Science policy Production of (basic) scientific knowledge Public research funds and grants, research laboratories and institutes, research associations, higher education Technology policy Advancement and commercialization Public procurement, technical vocational of technical knowledge education and training, regulations for product standards, technology forecasting, FDI regulations, import licenses, clusters, industrial parks and incubators Innovation policy Strengthening the innovative performance R&D subsidies (tax incentives, loans, of domestic firms loan guarantees, etc.), provision of equipment or services, intellectual property rights regulation, state venture capital

Source: Authors.

Setting the boundaries of public policies is never an easy task because policy areas can overlap and policy instruments rarely serve only one objective. For example, investing in an education policy instrument such as technical vocational education and training can also be considered a technology policy instrument because it strengthens absorptive capacity, equipping the labour force with technical skills and capabilities that can allow workers to move to more productive industries and economic activities. Similarly, imposing import licenses, a trade policy instrument, can influence the innovative performance of an economy because it can foster domestic technology development. Innovation also requires considerable financial resources, as R&D is generally costly and the uncertain nature of the innovation process requires firms to go through processes of learning and trial and error. Given this, investment policy instruments such as loans and venture capital are key to spur innovation.

Source: Authors' elaboration based on Guadagno (2015a), Lundvall and Borras (2006), and UNCTAD (2007c).

4.4.1 Public research programmes and has documented these successes, detailing gov- government-supported research institutes ernment policies and amounts disbursed (Lan- glois and Mowery, 1996; Levin, 1982; Mowery and In the domain of science policies, public research Rosenberg, 1993; Mowery and Nelson, 1999; and programmes, especially in the United States, more recently, Block and Keller, 2011; Mazzucato, have contributed to great scientific and tech- 2013; Wade, 2014). nological breakthroughs such as the Internet and personal computers. The US Defense Ad- Most countries in the world, however, cannot vanced Research Projects Agency initiated and equal the financial and human resources of the managed most of these programmes, providing United States, although some public research them financing and establishing research- net programmes have been or are in the process of works around them. These programmes were becoming quite successful.80 Most developing 80 See, for example, the exploratory and not purely scientific in nature, countries have neither a private sector capable Technology Development allowing firms to benefit from this research, of absorbing publicly funded research nor an in- Programmes in Taiwan Province of China (Hsu and learn from it, and finally commercialize prod- novation system that can generate the sort of in- Chiang, 2001). ucts that originated there. Abundant literature novations produced by advanced economies. So

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module Industrial Industrial policy: a theoretical and practical framework to analyse and apply industrial policy 100 and technology transfer.technology and learning,spillovers, mutual knowledge for scope the reduce sector productive the with linkages intense Less phase. commercialization the from far and applied less i.e. basic, more is research case,latter the industries.In those in innovation for trajectories technological promising the on guidance providing and risks and costs their ing reduc- by firms’ entry facilitating and industries new into programme,venturingtransformation structural government’s the in actor fundamental a GRIs makes and sector collaboration private the for with potential the increases This phase. commercialization the to closer are that research is more applied, technologies to leading case, former the In focus. scientific broad a have or areas industries/technological specific to ed dedicat either are period.post-war They the ing institutes dur countriesvarious in up set been have (GRIs) research Government-supported fusion andmutual learning. dif knowledge facilitate to them with cooperate to invited be can firms local and established, be into.tap can Government research can institutes firms that base knowledge a creating by process scratch. Public policies can therefore facilitate this todifficult upit set an in-house R&D centrefrom resources,human however,and find might firms financial limited with countries In centres. R&D in-house own their establish and engineers able knowledge- and skilled employ to firms requires sorptive capacity (Cohen and Levinthal, 1990). This ab- acquire to need firms words, other In TNCs). public in (whether researchfirm the or institutes outside produced knowledge the use and sorb, ab- understand, them help can that knowledge prior some first, accumulate to At do? need firms countries developing in governments can what - - - Lee andLim, 2001; Mathews, 2002). 2015; Lee, 2014; (Cheon, R&D for incentives fiscal their effortscan stimulate through financial and governmentsprocesses, and products new with up come and knowledge novel generate to able be to knowledge prior necessary the cumulated ac- have firms domestic When leaders. market policies helped to turn domestic firms into global industry. These computer and equipment tions technologies, for example in the telecommunica- new develop to model exten- learning this used governments sively Asian East in-house centers.incipient R&D with firms for learning of firms, and even foreign firms can be an effective domestic means GRIs, involving consortia R&D tic andforeign (Mani, firms 2010). domes- by employed later be could who workers skilled of pool a created and knowledge entific - sci advanced district, Bangalore the in mainly located institutes, research of number a ample, industry,aerospace Indian the dustries.In forex in- some by catch-up successful to contributing GRIs of examples are there levels, income lower at Even 2002). (Goldstein, firms local for bilities capa- of accumulation and creation knowledge for be can GRIs important how jects,confirming proresearch- its of some over advancedtook Embraer that so were activities research Its 1992). Frischtak, and (Dahlman in- countries dustrializing in institution research advanced most the probably became time,States. it OverUnited the Technologyof in Institute Massachusetts the on modeled research aeronautical for organization umbrella an as 1945 in established was ospacial) space TechnologyCentre(Centro TecnológicoAer Aero- the Brazil, In 1992).(Kim, ITRI as task same the accomplished 1966, in established Korea, of Republic the in Technologyand Science for tute countries.industrializingKorean Insti- other The in well as GRIs been havethere 17),Boxalthough (see regard this in instructive particularly is na in TaiwanChi- ITRI of Provinceof experience The - - Industrial policy: a theoretical and practical framework to analyse and apply industrial policy

Box 17 2 Government-supported research institutes: The experience of the Industrial Technology Research Institute in Taiwan Province of China module One of the most successful cases of GRIs is certainly ITRI in Taiwan Province of China. It was established in 1973 and located in the Hsinchu Science Park. According to Hsu and Chiang (2001: 127), “ITRI is responsible for conducting two types of technical work. It firstly develops innovative technologies for the establishment of new high-tech industries and then it integrates relevant technologies into existing industries to improve their manufacturing processes and quality.” In other words, ITRI explores promising technological areas and experiments with technologies that have a commercial potential; this means that ITRI itself develops and tests prototypes of potential new products.

It is undisputed that ITRI has played an enormous role in the transformation of Taiwan Province of China from a low-tech, labour-intensive economy to a modern high-tech economy. In general, the role of GRIs in the industrial policy of Taiwan Province of China was such that in the first phase of implementation of STI policies, only GRIs received state support to develop new technologies. At a later stage, cooperation between GRIs and firms with incipient R&D programmes was encouraged, and only then were firms entrusted to perform publicly funded R&D (Hou and Gee, 1993). While in the late 1980s ITRI’s budget accounted for 16 per cent of total R&D in Taiwan Province of China and 0.2 per cent of its GDP, by the late 1990s these figures had been halved (Guadagno, 2015a).

How did ITRI achieve such an impact on the innovation system of Taiwan Province of China? As discussed in Section 3.1.6 of the main text, innovation is a systemic endeavour of a number of interconnected actors in the economy. The stronger the linkages between these actors, the faster the knowledge diffusion and the greater the innovation rate of the economy. Subordinated to the Ministry of Economic Affairs, which determines its research focus, ITRI is an integral part of the complex system of innovation of Taiwan Province of China, a system composed of a large number of institutions and governmental bodies (Hou and Gee, 1993). ITRI was, and still is, well embedded in the institutional STI system and connected to the productive side of the economy. It is located inside the most dynamic science park on the island. The co-location of ITRI with many other research institutes and high-tech companies facilitated opportunities of knowledge-sharing and learning. ITRI also licenses its technologies to local firms, offering better conditions than foreign firms. As mentioned in Section 4.4.2 of the main text, ITRI spun off a number of high-tech firms that later became successful global players (e.g. the Taiwan Semiconductor Manufacturing Company, the world’s largest semiconductor foundry). It has been estimated that since its foundation, ITRI has spun off 162 firms and contributed to the creation of many others.

Source: Authors.

4.4.2 Attracting foreign direct investment jobs, investment opportunities, and knowledge spillovers (Borensztein et al., 1998; Lipsey, 2002; FDI can be a channel for technology transfer, Markusen and Venables, 1999). Yet, it can also be and is therefore particularly relevant for low- argued that these benefits depend on the size income economies, where innovation efforts are and type of FDI (see Box 18), its mode of entry, the geared towards absorption of foreign knowledge characteristics of the host country, and how much and technologies.81 The role of FDI in economic the government is able and willing to direct such 81 The literature has identi- growth and development has been an important inflows (Lall, 2000; Moran, 2011, 2015; UNCTAD, fied several mechanisms topic of discussion in the literature.82 It can be 1999, 2000, 2006c; Wade, 2010). The impact of FDI for technology transfer: FDI, licensing, consultancy argued that the inflow of foreign investment on host economies might even be negative, for and technical agreements, should automatically benefit the host economy, example by crowding out investment opportuni- trade in capital goods, joint as FDI can relax financing constraints, increase ties for local entrepreneurs (Kumar, 1996). ventures, subcontracting, competition, bring in technology, and create new exports, labour mobility, and technical developmental assistance (UNCTAD, 1999).

82 For reviews, see Lall (2000) and UNCTAD (1999, 2000, 2006b, 2006c). For the role of FDI in African development, see UNCTAD (2005a).

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module TAD (1995). Korhonen- (1994)andUNC 1962). For more details, see appeared in1962(Akamatsu, inEnglish discussion first inJapanese.in anarticle The Kaname Akamatsu in1932 was originally formulated by 85 85 84 83 2000). ment, seeUNCTAD (1999, and acquisitionsondevelop- lic ofChinaandIndonesia. the People’s in dustry Repub- the automotive in- case of Guadagno (2015b)forthe Industrial Industrial policy: a theoretical and practical framework to analyse and apply industrial policy For the impact ofmergers Forthe impact The flyinggeeseparadigmThe See Lo and Wu (2014)and 102 high knowledge transfer potential. transfer knowledge high have acquisitions and mergers and investment, and employment additional create can ments invest Greenfield FDI. of impact developmental the affect also can entry of Modes mining. and oil as such industries in specialize to economy the pushing by growth economic long-term ing by establishing enclave sectors; and (c) constrain- heterogeneity structural reinforcing (b) labour; to superior technology, access financing, and better-skilled have usually that firms foreign with compete cannot who producers local displacing (a) by it hurt even can and economy host the for benefits limited generate FDI, market-seeking and resource-seeking as FDI,such of types Some n pbi poueet o oeg investors. foreign to procurement public and programmes privatization opening by couraged and bureaucratic procedures. FDI has also been en- restrictions,reducing by controls,FDI forronment factors. Governments can create an enabling envi - Public policies have a roleto play in these shaping transfer andknowledgespillovers. technology for opportunities multiplying nents, potentialof compolocaland inputs of suppliers - network a firms foreign offers sector productive domestic a of existence The structures. ductive pro- and capacity, absorptive education, institutions, infrastructure, of quality the of terms economy, host the of characteristicsin especially developmental impact of FDI also depends on the Technology-leveraging literatureThe identifies several which products technology scope, Strategic driver offoreign investment. Market-seeking mergers andacquisitions. cal Resource-seeking advancedtechnologically economies. (e.g. as definitions Efficiency-seeking minerals, Source: Authors'elaboration basedonDunning(1993), Kaplinsky andMessner(2008), UNCTAD (2006b), and World Bank(n.d.). Box 18 maintaining market

technology,

may and

in oil, asset-seeking

rather other be of and such

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Types offoreign direct

the 83

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market the

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markets

allow and demand costs technology-leveraging

markets products by - other

and FDI them the of asset-seeking comparative asset-seeking rise to the “flying geese” paradigm. geese” “flying the to rise giving region, the in countries advanced less in firmsnese “recycled” comparative the advantage Japa- economies. Asian East of process alization - industri the in role important an played has FDI try, alwaysthis policyhasnot worked. but from imports and from the pressure of market en- protection investors’ market foreign granted also country.the Intelinvested in countriesSome have when example,for Rica, Costa in happened what firms.other for is signal This a as work can this as FDI, more attract to strategy effective an be can firm international renowned a attracting regard, a promote positive international image and of the country. In this incentives the on information disseminate to initiatives promotional by panied accom - be can initiatives These exemptions. tax generous and infrastructure efficient with zones SEZs,up governmentsManyset EPZs, tax free and na). Following the flying geese paradigm, FDI was China, Indonesia, Singapore, and Hong Kong (Chi- Korea, of of Republic Province the Taiwan efiting became a major foreign investor the in region, Japan ben- consequence, a in As industries. advantage those comparative a with economies nearby to move to producers Japanese couraged en- advantage) comparative dynamic country’s the with line in longer no declining were that industries (i.e. industries “sunset” to restructure policies industrial Japanese shows, erature in exporting production, overlap or commodities), host response that investment because to by

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- Industrial policy: a theoretical and practical framework to analyse and apply industrial policy 2 first concentrated in extractive industries (due to that it was exactly this premature entry in high- the need to fuel industrialization at home), and tech industries that restricted their chances of module later shifted to (mostly labour-intensive) manu- technological upgrading. Skipping the stage of facturing. This process was replicated when firms specialization in medium-tech industries left from the Republic of Korea and Taiwan Province them dependent on imports of capital and in- of China moved production in second-tier NIEs termediary goods, thereby limiting linkages of in Southeast Asia. Indeed, inherent to the flying FDI with the rest of the economy (UNCTAD, 1996, geese paradigm is the progression of FDI in terms 1999). The gap between first-tier and second-tier of countries and industries (UNCTAD, 1994, 1996). NIEs can be observed in many cases, from Malay- sia to the Philippines and Indonesia. These pat- Second-tier NIEs, however, could not replicate the terns, unfortunately, are not new. Some authors trajectory of first-tier NIEs, mostly due to the dif- have expressed concerns that insertion in inter- ferent nature of their interactions with foreign national trade based on the maquiladora model investors (Akyuz et al., 1998; Hobday, 1995; Lall and in Mexico and other Central American countries Narula, 2004; UNCTAD, 1994, 1996, 1999, 2002). has not led to sufficient accumulation of knowl- Southeast Asian economies still faced difficulties edge and capabilities, reducing the opportunities in upgrading to high value-added activities, even for technological and structural change (Katz, though they had managed to enter dynamic in- 2000; UNCTAD, 1999).86 Box 19 discusses the ex- 86 The term maquiladora dustries such as electronics and electrical engi- periences of the Philippines, Indonesia, and Costa (or maquila) refers to the neering (Wade, 2015). Instead, it has been argued Rica with FDI attraction and industrial upgrading. most common type of EPZs in Mexico and other Central American countries. Box 19 TNC affiliates locate the Transnational-corporation-dependent industrialization strategies: The cases of the Philippines, labour-intensive, assembly- Indonesia, and Costa Rica type activities of their value chains there, importing all In the Philippines, the establishment of an EPZ with modern infrastructure and preferential tax rates, com- the inputs and intermediate bined with favourable domestic conditions such as low wages and an educated, technically capable, and goods required for assembly. English-speaking workforce, managed to attract FDI, especially in electronics. FDI contributed to employment growth and diversification away from resource-based industries. However, these EPZs became enclaves with limited linkages with domestic economic activities, restricting opportunities for knowledge and technology transfer. Moreover, as complementary STI policies were not adequately implemented, technological upgrading was difficult, and the activities performed by TNCs generally had low value added. A similar situation occurred in the Indonesian automotive industry, which attracted many (especially Japanese) market leaders, but could not effectively link them with local SMEs. Local content requirements imposed by the government on foreign firms in exchange for market protection were rarely adhered to, as domestic firms could only produce low-tech components, and limited incentives and policies existed to upgrade their capabilities. To address these issues, the government has recently set up a government-supported research institute to foster knowledge creation in the industry (Guadagno, 2015b).

Costa Rica can also be listed as one of the most successful cases of FDI attraction, culminating with the 1996 investment by Intel. The FDI received by Costa Rica was efficiency-seeking and aimed at benefiting from the country’s resources, such as its geographical position, educated workforce, political stability, and the favourable fiscal regime offered by the government. FDI resulted in substantial export growth and diversification of exports, mainly towards electronics and electrical equipment. Industrial upgrading, however, required the government and local firms to undertake complementary investments in order to keep up with the infrastructural, educational, and innovation requirements of foreign investors. As a consequence, activities performed by TNCs remained limited to the lowest end of the value-adding process of the value chain. Therefore, although Costa Rica managed to diversify its export structure towards high-tech industries, the activities performed in Costa Rica had little technological and knowledge content, requiring minimum skills and limiting the potential for knowledge spillovers and learning opportunities for local workers and firms (Paus, 2014).

Source: Authors' elaboration based on Guadagno (2015b) and Paus (2014).

This empirical evidence suggests that attraction in Northeast Asian economies played a huge role of FDI in itself is not enough to initiate and spur in maximizing benefits from FDI. structural and technological change. The positive dynamics from FDI that, through technological So, what can governments do in this regard? transfer, strengthened domestic capabilities and Through selective seclusion (i.e. the selective export sophistication in the Republic of Korea opening of industries and economic activities to and Taiwan Province of China were not replicated foreign investment) and complementary invest- in second-tier NIEs and elsewhere. Public policies ments in education and infrastructure, govern-

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module 88 88 87 Industrial policy: a theoretical and practical framework to analyse and apply industrial policy et al.Hsu et (2009). Taiwan Province ofChina, see see Farla al. et (2015). For et al.Vicente et (2014). Mohnen (2010)andZúñiga- literature, seeMairesse and For examples from Europe, Forthis areview of 104 generally in high- or middle-income countries.middle-income or generallyhigh- in albeit used, widely been have reductions tax or preferentialof form creditsthe in subsidies R&D Research anddevelopment4.4.3 (UNCTAD, insecond-tier NIEs not 1996). first-tier but in implementedwere policies these services they require for their operations. Most of and goods intermediary the supply with to TNCs them enable to as so SMEs local strengthen to policies and innovation, and capabilities of tion - accumula the for incentives policies, education complementedby be also can measurestraction at FDI 2014a). (UNCTAD, capabilities and edge knowl- of transfer the facilitating enterprises, foreign and local between linkages strengthen to way a be can ventures joint promoting re - gard, this In employment. local and transfer ogy technol- and knowledge for example for TNCs, with negotiate firms help also can Governments locations. cheaper find investorsforeign when it retain and FDI strategic more attract can ments o eape RD netvs n h Republic the in incentives R&D example, For logical areas, but they are expensive instruments. R&D,techno- in promising and new in especially invest to firms push to used are incentives Such 5.2.1, Ethiopia of successful experiments withSTI canalso befound policies inlow- andlower-middle-income countries. Low-income Source: Authors. several ern Moreover, face when ers’ Development not Centre and of that In For streamlining port tutions Cambodia renewable energy(WIPO, These from Box 20 other Cambodia

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human to structural especially countries out, private investments. but have indeed crowded in, rather than crowded centives haveto additional led R&D investments, in- R&D that the find and Europe) and States United (especially economies developed on incentives focus R&D of additionality on studies cal - empiri the of incentive.Most taken the without place not have would that investments cover to used were incentives R&D if determine to i.e. incentives, R&D of additionality the estimate to literature has developed econometric techniques so R&D subsidies might crowd privateout it, R&D. The in invest to ready are entrepreneurs firms and private opportunities, profit interesting It can be argued that if a technological area offers (Maskus,ment 2015). have been subject to relatively little WTO enforce- subsidies R&D fact, of matter a As 5.2.3). Section these countries havethat today (see policy space cal change in industrialization the and restricted technologi- of role recognized the given future, would particular these use subsidies more the in 2015a). It is expected that developing countries in (Guadagno,1980s the of half second the in GDP of point percentage a half almost cost Korea of and reliable husbandry et al., et financial government

development the attract where producing industry, government of

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Industrial policy: a theoretical and practical framework to analyse and apply industrial policy 2 5 Current challenges to On the demand side, efforts to develop competitive industry are constrained by low income lev- industrialization and industrial module policy in developing countries els that limit the size of domestic markets and restrict demand to a limited range of usually The relatively meagre results of policies based low-quality products. Low incomes also result on the Washington Consensus, the effects of the in low government revenues because the state 2007–2008 financial crisis, and the slowdown is able to raise less through taxes, which subse- in growth rates of emerging economies after quently leads to significant budget constraints 2010 all contributed to bringing industrial policy that further limit aggregate demand. To over- back into the spotlight. Moreover, evidence that come insufficient domestic demand, developing a middle-income trap is limiting opportunities countries often turn to external markets. For the for industrial upgrading and accelerating de- least advanced countries, external markets are industrialization in several Latin American and difficult to reach because of poor infrastructure Southeast Asian countries also suggested a need within the country and built out towards hubs to return to industrial policy (Felipe, 2015; OECD, outside the country, which in turn affects trans- 2013b; Peres, 2009). In addition, there is a concern portation costs, profitability of firms, and coun- that the commodity price boom that affected tries’ competitiveness. Research shows that such resource-rich economies during the first decade factors lead to segmentation of markets, prevent- of the 21st century (see Section 3.1.3.5 in Module ing firms from taking advantage of economies of 1) could accelerate deindustrialization, generat- scale or investing in new products and new and ing economic growth, but with little equity and better ways of production (Bigsten and Söder- employment. bom, 2006; Porter, 1990). Public procurement and policy instruments for export promotion are This shows that developing countries still face the key policy instruments to relax demand-side a number of challenges to industrialize. These constraints. challenges are the result of internal and external conditions. The next sections focus on some of On the supply side, developing countries gener- these issues, paying particular attention to those ally lack skilled labour, basic infrastructure such that are the most pressing for low- and middle- as electricity and roads, and a science and tech- income countries. nology infrastructure that allows for the use of modern technologies such as ICT. Domestic firms 5.1 Challenges from internal conditions need these prerequisites to boost their capabilities and competitiveness. Often, only a few Economies face different constraints and op- firms are technologically capable of competing portunities resulting from differences in their on global markets, leading to the structural het- human, institutional and economic develop- erogeneities described in Module 1. Most of the ment, policy priorities, location, history, and en- policies discussed in Section 4 can be thought of dowments. For this reason, industrial policy and as supply-side policies tackling supply-side con- national development strategies need to be constraints to production. text-specific. At the same time, countries share some common features that allow for some Structural heterogeneity can obstruct a policy- adaptation of successful policies. The following driven process of structural transformation discussion highlights some of the country condi- because of weak linkages. Gains from growth tions that affect industrial policymaking in de- in leading sectors must be linked to the rest of veloping economies. the economy; otherwise structural heterogeneity will be reinforced, slowing down industriali- 5.1.1 Level of economic, institutional, zation and development. Developing countries and human development also have to deal with a scale issue posed by the prevalence of small and mostly informal firms. Constraints and opportunities for structural Widespread informality has consequences for transformation are closely associated with the the formulation and implementation of indus- existing level of a country’s economic, institu- trial policy through several channels. Informal- tional, and human development. This section ity tends to be concentrated in small enterprises reviews demand, supply, and structural factors that cannot take advantage of economies of that represent a challenge to policymaking in scale. In these firms, opportunities for learning developing countries, and discusses the impact are typically constrained by low capital intensity of institutional and human development on in- and the nature of the activities performed, gen- dustrial policy implementation. erally requiring unskilled labour. Informality also makes it difficult for the government to reach en-

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module Industrial Industrial policy: a theoretical and practical framework to analyse and apply industrial policy 106 living conditions (UNCTAD, andwell-being 2011b). ing, alsobut the includes poor and improves their manufactur to agriculture from labour shifting with concerned only not is transformation tural der to make sure that economic growth and - struc or in policies economic other with coupled be to levels.erty As a consequence, industrial policy has pov rising to leads poor,even the growth or pass in other cases the benefits of economic growth by associated is with large reductions in the growth number of poor, while economic cases, some In development.human and fostersocial to enough in Module 1, economic growth 4.2 Section in discussed As levels. education low or workers, of conditions health poor nutrition, mal - through example for policymaking, dustrial in- affect can development human of levels Low al. 2008; Khan, 1996). (Cervellati institutions weak by characterized contexts in achieved be also can development economic as development, with strengthen and evolveinstitutions that argued policies,be can it industrial of implementation and design the to contributed extent some to have factors tional institu- these While 2014). Melia, and Altenburg 2013; (Altenburg, conflicts in- ethnic and deepening equalities to and fragile and small sector private the leaving to contributed This failures. correct to difficult it made and directions wrong the in incentives policy industrial curbed often informalloyaltynetworks centralizedand power which in system a created institutions weak and inequality that argued been has it example, for case, African the In on. so inequality,and levels, income structures, production affectingsociety, the in rents and power of distribution influence also Institutions bureaucracy. its and state of the capacity higher the to thanks instruments, policy industrial of set wider a use to ernments gov enable and policy such facilitate stitutions in- Strong policy. industrial effective an of tion implementa- and design the in face countries that challenges institutional major the outlined already have 3.3 and 2.3 country, Sections the of development institutional the to respect With services. non-tradable and agriculture as such sectors ity the labour forceof isemployed inlow-productiv share significant a countries developing in that show 1 Module in presented statistics force. The labour the of distribution sectoral the in evident of the structural transformation challenge is also intervention.scale government for The rationale additional an providingrevenues, tax decreases informality widespread more, is What schemes. spheres of state regulations and public incentive the outside operating workers and trepreneurs per se might be not et et ------forthcoming). (Vrolijk, transportation in investment future for prospects encouraging by and costs labour low relatively its to thanks mainly investment, tract at to able is Ethiopia time), and costs transport lematic transportation systems (both in terms of spect. Despite being landlocked and having prob- re- this in illustrative also is Ethiopia of case The 2012). (Chang, not does set latter the transport, river good has countries of set former the while landlocked,Zimbabwe, but areFaso and Burkina also but Austria, and Switzerland poorly. form makesthat transportation in such countries per investment of lack the country,ratherthe but of Critics of this view argue that it is not the location Melia, 2014). and (Altenburg obstacles logistic circumventing for allows that industry services tradable strong a integration,develop regional throughor bours neigh- coastal with relations their improve can ness. To overcome these circumstances, countries competitivetheir - hurt that prices sale higher to lead turn in which costs, transportation higher face routes trading or markets consumer major from away further economies Landlocked kets. fect a country’s abilityto compete on global mar af can economy an of location 2004). The al., et Sachs (Collier,2007; structures production their transform and grow to ability their determines tries, and essentially whether they are counlandlocked,- of location the that argue scholars Some 5.1.2 Location andendowment shouldalso becarefullyservices considered. social against policy industrial costsof portunity low-income of space countries,fiscal ited op- the lim- the Moreover,given2015). Lütkenhorst, and Altenburg also (see wages decent and ployment em- productive ensure and society of parts able vulner most the account into take view,should forcalls policy”,“inclusiveindustrial which, his in poverty.with cerned Toend,this (2011) Altenburg con- also growth-oriented,but be only not must policy industrial that shows This classes. social particular favour implicitly might liberalization advantage) comparative a have countries oping devel- many where (i.e. industries source-based re- towards resources channelling Moreover, by regime. new the to adapt to producers for ficult dif it make also quick might but achieve gains, productivity might countries developing in liberalization rapid industrial example, For in policymaking. themselves manifest can equity of trade-offsefficiencyhow economic and between examples several provides (2011) Altenburg resources withnatural ------Industrial policy: a theoretical and practical framework to analyse and apply industrial policy 2 Endowments with agricultural and mineral re- tax and royalty revenues, to promote industrial sources vary greatly across countries. Industri- development of non-commodity industries (Kap- module alization of resource-rich countries may be chal- linsky, 2011; UNCTAD, 2014b). Industrial policy can lenged by Dutch disease effects (see Sections 3.1.2 leverage these fiscal linkages. Throughout histo- and 3.1.3.5 in Module 1). A boom in commodity ry, governments have accumulated the financial prices during the first decade of the 21st century resources required to be able to consistently im- and the discovery of reserves of minerals and fuel plement an industrial policy in part through the in many developing countries allowed resource- appropriation of natural resource rents (UNCTAD, rich countries to take advantage of favourable 2011a, 2012, 2014a, 2014b). Indeed, the realization terms of trade. These recent developments have that oil and gas will run out in the future has mo- prompted some scholars to challenge the view tivated many governments to begin to use these that natural resources must necessarily repre- resource rents to underpin an industrial policy. sent a curse for developing countries (Torvik, 2009). Instead, they argue that with the right pol- For example, in the mid-1960s, the discovery of icy approach, commodity-based activities can be significant reserves of oil and gas in the North Sea beneficial to countries that wish to industrialize. created a once-in-a-generation opportunity for This literature identified production linkages be- the Norwegian and UK governments. In Norway, a tween commodity industries and the rest of the major industrial policy programme was designed economy that can sustain structural transforma- to capture the benefits of these reserves. The gov- tion and the rise of modern industries (see Box ernment established a SOE, Statoil, which quickly 3 in Module 1). These linkages and externalities became a key player in the national industrial would justify government intervention. Govern- development effort thanks to its licensing agreements can intervene to strengthen production ments with international companies to transfer linkages and maximize the extent to which local technologies to local companies and help them firms can benefit from innovations and knowl- build their capabilities through local content edge creation in the commodity industry. agreements. Thanks to this strategy, Norway managed to develop a whole array of new indus- Country experiences demonstrate how difficult it tries, some world-leading technologies, key R&D can be to realize and maximize linkages. For ex- institutions, and quality educational institutions. ample, in Mozambique, in order to complement This policy helped sustain and drive forward its the investment in the Mozal project (the alu- district of new innovative SMEs in the Stavanger minum smelter created at the end of the 1990s), region (Hatakenaka et al., 2006). Similarly, in Chile, the government attempted to establish linkages the state-owned CODELCO (National Copper Cor- with local SMEs through the SME Empowerment poration of Chile, or Corporación Nacional del Linkages Programme. However, the programme Cobre), the world’s largest copper producer and did not meet with great success, as knowledge one of the most profitable facilities in the world, spillovers were limited and local SMEs failed to ac- channels part of its revenues into the state budg- cumulate sufficient capabilities (Ramdoo, 2015). In et. These resources helped Chile finance many of Botswana, the Mineral Beneficiation Policy, in co- its most important industrial development and ordination with the National Development Plan, social programmes such as Fundación Chile and is creating a comprehensive incentive system to CORFO (Chilean Economic Development Agency, attract firms in the diamond processing industry, or Corporación de Fomento de la Producción de and to develop a knowledgeable workforce em- Chile) (see also UNCTAD, 2006d). ployable in this skill-intensive industry. Incentives include tax benefits, reduction of red tape for The recent commodity price boom (see Section expats employed in the industry, incentives for 3.1.3.5 in Module 1) has prompted governments to knowledge and skill transfer from foreign experts, attempt to increase natural-resource rents and and skill accumulation within local knowledge reduce incentives to investment, given the high- centres (Mbayi, 2011). Finally, it can be argued that er attractiveness of such investment in times of infrastructure investments to facilitate transport price booms. To this end, governments updated of commodities can create positive externali- their regulatory and fiscal frameworks, increas- ties in other industries, regions, or neighbouring ing royalty and corporate tax rates, introducing countries (Perkins and Robbins, 2011).89 new taxes, renegotiating contracts, and increas- 89 For more examples, see ing state equity participation in extractive com- the outcomes of the Making Apart from production linkages, fiscal linkages panies. In spite of these reforms, government rev- the Most of the Commodity Price Boom Project. Available can also benefit the modern sector, fostering enues did not grow as much as firms’ profits from at: http://dpp.open.ac.uk/ structural transformation. Fiscal linkages re- extractive activities, showing that during the research/projects/making- fer to the possibility for the government to use price boom, incentives may have remained too most-commodities. commodity revenues, for example in the form of generous and created losses in public revenues.

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module 2005). ing awaythem (Farfan, from face difficulties indiversify production withinGVCs and resource-intensive stagesof ing economies specialize in situation inwhichdevelop- trap”modity refersto a 91 91 90 Industrial policy: a theoretical and practical framework to analyse and apply industrial policy diction (UNCTAD,diction 2014b). - juris tax countryto alower natural-resource-producing the of jurisdiction tax the TNCs canmove profitsfrom operations.firm this In way, undervaluing inintra- prices profits byinflating costsand referto TNCs manipulating the extractive industries, practices, common in The expressionThe “com- Transfer mispricing 108 - forms (UNCTAD, 2014b). re- the of efficacy the reduced further practices, ing practices of TNCs, such as transfer mispricing account and planning Moreover,tax aggressive pressures.of types variousof result a as changes regulatory their implement to not decided tries coun- Several frameworks. fiscal and regulatory new the enforcementlimited of of sign a be also might revenues government of growth Limited developing countries can be successful in insert in successful be countriescan developing while 4.4, Section in explained As them. within capabilities their upgrade and GVCs into grate inte- to options policy industrial countries’ ing develop- the discusses section 1). This Module of 3.1.3.4 Section GVCsgenerally(see areas TNC-led FDI, with experiences recent more and past the from lessons policy the on builds This also literature GVCs. in upgrading and insertion successful for policies industrial on exists literature huge A services. and goods in than GVCs,rather internationaltrade by specializing tasksin the of into integrate countries and scenario,firms new GVCs.of this rise the In and production global of fragmentation the to led has globalization1, ule Mod- of 3.2.4 and 3.1.3.4 Sections in discussed As 5.2.1 Policies in developing countries. policy industrial and industrialization to lenges chal - global pressing most the surveys section This agreements. regional and multilateral by linkages, facilitated financial and trade through integrated more become economies their as ing shrink is countries “policy developing many the of space” that claim some Moreover, today. results same the deliver to fail may competitive havewould become morefirms domestic helped ago two or decade a that Strategies countries. developing for opportunities presents also but challenges poses that environment global ing fast-chang - a to contributed have that opments economic powerhouse, are some of the an key devel- as China of Republic People's the of rise the and GVCs, of emergence the and Globalization 5.2 (Ocampo,getting halted oraborted 2014). paramount to avoid the industrialization process is policy rate exchange careful a cases, these In manufacturing. penalize that rate exchange the of overvaluationscyclical from suffer economies resource-abundant 1), Module in 3.1.3.2 and 3.1.2 Sections (see argued have economists turalist - struc As economies. resource-rich in important Finally, exchange rate policies are also particularly conditions from external Challenges value chains to profitably integrate into global 90 - - - onre cn vi “omdt traps” “commodity avoid can countries upgrading, Through 4.4.2. Section in shown as of GVCs (Milberg context the in inefficient deemed are activities, exporting for crucial are that imports chain),supply the of on parts restrictions tiple or mul- owning (i.e. industry integrated vertically a develop to subsidies as such instruments Policy activities, target services.or to goods ratherthan policy industrial requires This (UNCTAD, 2015d). strategies development in GVCs embedding is world GVC-dominated a in policy industrial of element first The GVCs. into insertion from efit ben- countries developing help can that actions policy main the of overview an provides Table9 task.ficult dif more much a is chains related in or chains these within electronics,upgrading like dustries in- high-tech in GVCs,even into themselves ing y eemnn te oe rltos ihn the within relations power the determining by countries developing in firms on have can GVCs Governance structures influence the that impact (Farfan,2005). products sophisticated more and upgrading towards higher-value-added activities and growth productivity for potential the mines and the existing level of capabilities, which deter firms,lead global with linkages establishing and scale of economies achieving for crucial size, as Governance such characteristics firm 2002). on depend structures Schmitz, and Humphrey Gereffi 2015; 2014, (Gereffi, opment devel- and industrialization on impact their and structures governance GVC on literature huge a is There chains. value those of govern- structures the ance by affected is GVCs in Upgrading various GVCs) (UNCTAD, 2011c). along activities various in capabilities of lation - accumu the GVC) (through diversification a and in role their upgrade to knowledge and skills of accumulation (through specialization between balance a strike to try doing should governmentsthis, In 2013b). 2011c, (UNCTAD, suppliers ary second- of cluster local a creating and firms cal lo- foreignand collaborationbetween long-term and partnerships stimulating by investments of “stickiness” the increase can policies vestment it. in- Tradeattracting and than important more even or equally becomes FDI retaining scenario, this In locations. new in opportunities business new creates continuously countries developing between competition and vanish develop countries easily as can costs low on Competi- based volatile. tiveness usually are TNCs by ments invest because necessary also is development industrial of view dynamic A TNCs. on and kets, mar and technologies of range limited a on ent depend- them leave that traps middle-income 21) Ugaig s lo crucial, also is Upgrading 2014). al., et 2005; al., et 91 and - - - - Industrial policy: a theoretical and practical framework to analyse and apply industrial policy 2 chain. When some players gain too much power learning from competitors, suppliers, and cus- in the chain, they might adopt strategies to cap- tomers; (b) support for science and technology module ture higher shares of value added. For example, to enhance product quality and productivity, and by creating trade-related constraints in the form an effective intellectual property rights frame- of tariffs and other taxes, lead firms in down- work to give lead firms confidence in employing stream activities can reduce the profit margins state-of-the-art technologies; (c) business devel- of upstream firms. Alternatively, they might opment services such as business development hamper technological upgrading and entry into service centres and capacity-building facilities; downstream activities, for example by limiting (d) promotion of entrepreneurship through in- knowledge and technology transfers or by im- cubators, training, or support with venture capi- posing standards through trade and investment tal (see Section 4.2.3 for some examples); and (e) agreements (Milberg and Winkler, 2013; UNCTAD, access to finance for SMEs to support develop- 2014b). These strategies are likely to cement the ment of domestic capacity and allow small firms asymmetries in power and skills between de- to grow and reach minimum efficient scales of veloped and developing country firms. Govern- production (see Section 4.2.2). To this list, UNC- ments in developing countries can help local TAD (2011c) adds education policies, particularly firms negotiate contracts with foreign firms, for technical vocational education and training. example by encouraging long-term contracts between them, supporting collective bargain- The fourth policy element to cope with GVCs re- ing through producer associations, or providing lates to environmental, social, and governance training in bargaining and model contracts (Mil- challenges. Working conditions in firms supply- berg et al., 2014; UNCTAD, 2011c, 2013b). ing to GVCs have been a source of concern, especially when FDI seeks low-cost labour in countries The potential for upgrading also depends on the with relatively weak regulatory environments. characteristics of the private sector in the devel- Similarly, it has been argued that GVCs can also oping country. In particular, the quality and avail- facilitate the relocation of polluting production ability of local supply chains allow for lead firms processes to developing countries (Kozul-Wright to source intermediate inputs in the country and and Fortunato, 2012). In this regard, government build linkages with local suppliers. Moreover, an procurement policies can require compliance entrepreneurial drive in the local economy can with international labour, human rights, and contribute to the emergence and strengthening environmental standards. Additionally, EPZs can of a dynamic private sector (Farfan, 2005). Indus- provide assistance with labour issues, informing trial policy can foster these processes by support- firms about national labour regulations and pro- ing local SMEs, strengthening their linkages with viding support services. Similarly, EPZs can adopt TNCs and promoting entrepreneurship, as dis- environmental standards, for example in the cussed in Sections 4.2.2 and 4.4.2. form of environmental reporting requirements under which companies report their anticipated The second industrial policy element – enabling amounts of pollution and waste. Finally, in the participation in GVCs – refers to the importance area of good governance, it has been noted that of creating and maintaining an environment part of the earnings of TNC affiliates is some- conducive to business, as discussed in Section times repatriated, and consequently the value 4.1. In the context of GVCs in particular, UNCTAD created in the host country cannot be used by the (2013b) points to the importance of trade facilita- government of the developing economy. Govern- tion, for example by streamlining port and cus- ments are increasingly strengthening regulatory toms procedures, and investment facilitation, frameworks in this area, imposing fines and pen- including measures to streamline procedures alties in cases of non-compliance. related to entry and establishment of foreign- invested firms (e.g. registration, licensing, access The last policy area in Table 9 concerns the need to land, hiring, and taxes). for policy coherence, especially with regard to trade and investment policies. This has led many Building domestic productive capacity, the third governments to merge investment promotion element listed in Table 9, is paramount for indus- agencies and trade promotion organizations. trialization. UNCTAD (2013b) identifies a number These considerations, however, are context-spe- of policies in this area: (a) development of clus- cific, requiring case-by-case evaluations. tering and linkages to foster competitiveness via

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module Industrial Industrial policy: a theoretical and practical framework to analyse and apply industrial policy 110 eeoig ol (Fu world developing the of rest the in policy industrial forrepresents growth China’s that opportunities and lenges chal- the analyse to econo - begun have low-income Scholars mies. and middle- of catching-up processes the and globalization on debates currentattention in fairof receivinga amount is The fast the of growth People's Republic of China • • • observations: following the in noted as regions, these to FDI in increase an to and Africa and America Latin from exports higher to led has China of public RePeople's - of rise the that show Severalstudies GVCs.intocountries developing integratesother (c) and inputs; cheaper to access allows (b) ket); mar Chinese the by to going countries developing produced products (i.e. countries veloping de- other from exports for market a creates (a) China of Republic People's the in growth which to extent the on depend largely Opportunities UNCTAD, 1999, 2005b, 2010, 2011d; Weiss, 2013). Weiss, 2005; Naudé, 2010; Reiner and Staritz, 2013; Messner, 2008; Lall and Albaladejo, 2004; Lall and 5.2.2 and institutuons and investment policies Synergizingtrade governance framework environmental, and social Providing astong productive capacity domestic Building in GVCs Enabling participation in development strategy Embedding GVCs Note: GVCs: global value chains. Source: UNCTAD (2013b: 176). Table 9 - bil US$70 exceeding decade, last the during other developing countries has grown rapidly to India and China of Republic People's the from FDI (2008), Ulltveit-Moe to According annually (Broadman, 2007). People's Republic of China grew by 48 per cent the to where between 1999 and 2004 exports Africa, of case the in found is trend similar A tween 1999and2005. Latin be- China RepublicPeople'sof the to America from exports in increase sevenfold a Jenkins countries. prices American Latin higher by exported commodities for to led has China People's of the Republic in growth economic that find Bizquez-Lidoy and (2006) Perry of rise The Key elements the People's Republic ofChina 21; alnk and Kaplinsky 2012; al., et (2008) also report report also (2008) al. et Implications ofglobal value chainsfor policies industrial • Creating "regional industrial development compacts" • Synergizingtrade andinvestment promotion andfacilitation coherence• Ensuring trade between andinvestment policies local enterprise incomplying• Supporting withinternational standards • Minimizingrisks withGVC associated through regulation, participation andpublic the workforce• Strengthening of skills enterprisethe bargainingpoweroflocal firms development andenhancing • Supporting the infrastructural• Puttinginplace prerequisites for GVC participation • Creating andmaintaining aconductive environment fortrade andinvestment along• Settingpolicyobjectives GVC development paths • Incorporating GVCs inindustrial development policies and private standards (2006) al. et - • • countries. Researchers have foundthat: sub-Saharanand African American forLatin tion industrializa- for opportunities offer necessarily not does capabilities, technological and human also but labour cheap of reserves large with try The rise of the People's Republic of China, a coun- run. longer the in benefits net the regardwith to countries,inconclusiveremains ing evidence the develop- other for opportunities create may na the People'sthe of growth While Republic of Chi-

Principal policy actions policy Principal products (Kaplinsky andMorris, 2008). high-tech and medium- were 2005 in China of Republic People's the from of imports total half about where countries, African for observed is pattern similar A manufactures. non-resource-based are cent per 85 productsover and manufactured are countries can - Ameri Latin by imported goods of cent per Lall and Weiss (2005) morethat than note 90 variationscountries,acrossNotwithstanding countries. developing by China of Republic People's from imported goods of type the to The pattern of trade is reversed when it comes pulp, fish, andleather. soya,as iron,such products ore, mary copper, - pri of consist China of Republic People's the to exports American Latin two-thirdsof than Jenkins 2005. 1995– during cent per 47 to ex 31 from exports panded Africa’s in gas and oil the of share that find (2008) Morris and Kaplinsky example, For China. of Republic People's to the manufactures resource-based and ucts prod- primary supply to tend countries ing Data on patterns tradeof developthat show - em- creation,ployment spillovers, andlearning. for opportunities more offer arguably that manufacturing as such sectors in than ratherenergy, and infrastructure, mining, in point out, most of the expanding FDI has been 2006.However,in lion Jenkins as 20) hw ht more that show (2008) al. et (2008) al. et - Industrial policy: a theoretical and practical framework to analyse and apply industrial policy 2 • Latin American countries have faced signifi- While it is undisputed that EOI strategies have cant Chinese competition, especially in high- produced extraordinary export growth and module wage and capital-intensive products (Jenkins greatly contributed to structural and techno- et al., 2008). For example, Dussel (2005) finds logical change in past industrial experiences, it that Mexico has lost production and FDI as is increasingly recognized that export-led growth a result of competition from Asia and par- cannot be an option for each country in the world. ticularly from the People's Republic of China. Export-led industrialization strategies must In Brazil, low-tech industries suffered the sooner or later reach their natural limits because highest losses of export markets to Chinese not all countries can simultaneously pursue such competition (7.2 per cent of 2004 exports), fol- strategies. This has been referred to as the “fal- lowed by the high-tech (2.1 per cent), medium- lacy of composition argument”. According to the tech (1.4 per cent), and resource-based indus- fallacy of composition argument, also referred to tries (1 per cent) (Jenkins et al., 2008). as the “adding-up problem”, what is viable for a small economy might not be viable for a group of Can industrial policy provide effective means economies, especially if they are large. In particu- to overcome these challenges and, at the same lar, according to this argument, large developing time, help take advantage of the new opportu- countries that try to simultaneously implement nities? Does the rise of the People's Republic of export-led strategies might encounter increas- China leave room for export-led growth of other ing protective resistance from other developing developing countries? Is a development strategy countries and might incur losses because prices based on labour-intensive industries still feasi- of manufactures would tend to decrease (UNC- ble for low-income countries? Should industrial TAD, 1999, 2002, 2005b; see also Mayer, 2003). This policy in developing countries shift attention is what happened, for example, in the clothing in- from exports and production for high-income dustry, where many developing countries, and in countries towards regional and South-South in- particular the People's Republic of China, adopted tegration and domestic markets? These are some export promotion policies. The stronger Chinese of the questions that arise from the findings of participation in international trade significantly this literature. contributed to the decline in the unit values of its major exports (UNCTAD, 2005b). This phenome- The People's Republic of China holds many ad- non might have negative consequences for other vantages over other developing countries. It developing countries entering those industries. benefits from significant reserves of labour, However, while this is likely to reduce the scope which are likely to keep wages low for at least for export-led growth and industrialization strat- some years to come, and it is increasingly build- egies based on labour-intensive manufacturing ing up local capabilities to foster innovation. in developing countries, such manufacturing is These advantages allow it, at least in the short no longer a comparative advantage or a develop- term, to maintain a large presence in the mar- ment interest of the People's Republic of China, kets for low- and medium-tech manufacturing which is trying to move to activities with higher activities. Increasingly, however, some of the skill and knowledge content (UNCTAD, 2005b). economic activities in the People's Republic of China are redirected towards other developing In addition to the arguments presented above, countries (e.g. Viet Nam or Ethiopia) where la- the 2007–2008 financial crisis and the subse- bour costs are relatively lower. This implies that quent economic recession in many developed as wages are rising, other developing countries countries have proved that foreign demand may be able to capture production of some of is not only finite, but that it can also be rather the low-labour-cost manufactured goods. FDI limited. Competition for export markets based from the People's Republic of China can poten- on cheap labour and low taxes is already lead- tially lead to technology transfer and knowledge ing developing countries to a “race to the bot- spillovers, but as we saw in Section 4.4.2, this is tom” that in the long run risks jeopardizing their not an automatic process. In order to re-create chances to integrate into international trade in the flying geese paradigm that allowed the Re- a sustainable manner. In light of this, large de- public of Korea and Taiwan Province of China to veloping economies might choose to re-orient benefit from Japanese FDI, governments in de- their industrial policies towards their (often ex- veloping countries should facilitate the transfer panding) domestic markets. This shift implies a of knowledge, technology and skills, and the ac- change in demand patterns and characteristics, cumulation of capabilities, for example by using as firms would increasingly need to cater to low- the industrial policy instruments described in and middle-income consumers in their countries Section 4.4. instead of high-income consumers in developed countries. However, moving to domestic-

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module enterprise. the to inflows attributable value offoreign exchange the areto allowed up ports ofanenterprise.imports Im- the volume of on restriction requirementancing asa acts 93 93 92 Industrial policy: a theoretical and practical framework to analyse and apply industrial policy agno (2015b), respectively. Ramdoo (2015)andGuad- incomemiddle countries see for low-income andlower- them, seeUNCTAD (2007a); the policyspaceavailableto African countries canuse The foreign-exchangeThe bal - For ofhow adiscussion 112 ing countries. These agreements may to varying to may agreements countries. These ing develop- by bilateral agreements investment and and trade regional, multilateral, of range wide a of conclusion the to led liberalizationhas economic of pursuit the decades, past the Over to pursueindustrial policy. have policymakers that maneuver for space the defines space policy words, other In 45). 2014b: tradeoffs”(UNCTAD, possible weigh and targets, specific influence priorities, set to policymakers national of ability the involvescontrol, which icy goals and instruments, policy and over policymakers national of formal authority the is which sovereignty, policy jure de of combination the as defined be can It context. ment that is best suited to its nationalparticular develop- sustainable and equitable achieve to policies most social and economic of the mix appropriate pursue and identify to government a of ability and freedom “the to refers space icy pol- of concept The NIEs. Asian East first-tier by trial policies is much narrower than that enjoyed indus- pursue to today have countries veloping de- that space policy the that argued often is It 5.2.3 Policy space consume (UNCTAD,ers donot 2013a, 2014b). consum- domestic that goods of production the through trade international into integrated are that countries for resources,or natural and ities developing specialize countriesthat in commod - for complex be might growth demand-oriented gemns wih eev seil teto in attention special deserve which agreements, (Rodrik, imports on 2004).strictions Several WTO re- quantitative of use the on limits and ments, require- content domestic as such requirements subsidies,use export prohibition of performance pices of the WTO. Among them are restrictions to tilateraltrade agreements the signed aus- under mul- under restricted or prohibited are exports promoting or markets domestic protecting tradeby affect that interventions selective Some Reciprocity: competitive produced domestically goodsorenterprises. between are Most-favoured-nation: Source: Authors'elaboration basedonRodrik (2004)andUNCTAD (2014b). National “alike” Box 21 applied, product two countries. treatment

Mutual they from anothercountry. cannot

: principle or

correspondent A

be product Trade andinvestment treated de facto national pol-

Once

made foreign less

concessions favourably in one goods member agreements: and of (e.g. advantages enterprises otherwise beforbiddenotherwise orrestricted. or use some policy instruments whose use would retain to countries developing allow that ment, above rules, such as special and differential treat There are, however, (temporary) exceptions to the definitions). for 21 Box (see requirements” kets) mar domestic in enterprises and goods foreign national to treatment(i.e. treatmentfor and equaldomestic commitment the and treatment most-favoured-nation the in reflected as nation, - non-discrimi and reciprocity of principles core able rules and commitments that are built on the enforce- and binding negotiated, of set a prises com- regime trade multilateral 82), “The (2014b: UNCTAD in stated as words, other In countries. between trade of flow efficient more a facilitate Multilateraltrade agreements are to rules up set Lall (2004). UNCTAD(2006,2014b),(2004),and on VRodrik ly agreements,investmentdraws particular it and multilateral,for and traderegional,bilateral and policies. signing and pursuing their trade and investment options they still have in terms of flexibility in de- face to due changes their in policy space, the and countries developing constraints the analyses it particular, In countries. developing of space icy changes in global governance that affect the pol- UNCTAD,1996, 2006). the focuses on section This 2002;Rodrik,2004;2011;Chang, (Altenburg, tries indus- domestic their support to have countries developing that possibilities the restrict extents ehooy rnfr requirements. transfer and technology restrictions, balancing exchange foreign employment,trade-balancingand requirements, local content, requirementslocal as such investors foreign on discriminatory imposing from Measures The TAD, 2014b). - (UNC below detail in context, discussed arethis

in country terms Agreement Definitionsof 92 cannot of or The discussion is conducted separately have (TRIMs) internal privileges satisfied

on terms treated rhbt sgaoy countries signatory prohibits taxation) in Trade-related whatever the less commercial than favourably border alike 93 Investment Empirical or measures relations than directly an - - -

Industrial policy: a theoretical and practical framework to analyse and apply industrial policy 2 evidence demonstrated that in the past these these activities to foreign investors. For this rea- instruments have been widely used to support son, the GATS is generally considered less binding module structural transformation, allowing developing than other agreements, although some observ- countries to derive greater benefits from FDI, in- ers insist that its reach is much broader than it crease linkages between foreign investors and appears, since it often covers a wide range of do- local producers (see Section 4.4.2), and estab- mestic laws and regulations (Chanda, 2002). lish performance-based criteria such as export targets (see Section 2.3). There is, however, some The Agreement on Subsidies and Countervail- flexibility in the agreement that allows countries ing Measures (ASCM) prohibits the use of sub- to utilize some industrial policy instruments. sidies contingent upon the use of domestic over For example, TRIMS does not prohibit countries imported goods (i.e. local content requirements) from offering concessions to foreign investors and export performance (i.e. export subsidies). (even if these may hurt domestic producers), as The agreement thus restricts the capacity of de- often occurs within EPZs and SEZs (see Section veloping countries to use these policies for the 4.4.2). Moreover, countries are allowed to impose development of domestic firms. Other subsidies, sector-specific entry conditions on foreign inves- such as production subsidies, are considered tors, including industry-specific limitations, local “actionable”, meaning that they are not prohib- content requirements for the procurement of ited, but can be challenged. As an exception to services, and offset clauses in defence procure- the agreement, countries that are classified as ments (see Box 15). least developed, or WTO member countries with per capita incomes below US$1,000 (in constant The Agreement on Trade-related Aspects of In- 1990 US$) for three consecutive years, are exclud- tellectual Property Rights (TRIPS) establishes the ed from this agreement. They can effectively use standards for granting and protecting intellec- export subsidies to develop domestic industries, tual property rights such as patents, copyrights, as long as they remain below that per capita in- and trademarks. The TRIPS agreement protects come threshold (see Annex 7 of the ASCM). R&D outcomes to allow entrepreneurs to appropriate the benefits that arise from their invest- Regional and bilateral trade and investment ments in R&D.94 The agreement restricts reverse agreements. In addition to multilateral trade 94 Alternatively, entre- engineering and other forms of imitative innova- agreements, the conclusion of regional and bi- preneurs would bear the tion, which in the current advanced economies, lateral trade agreements has further eroded the costs of innovations, but not the profits potentially including East Asian economies, has proven to be policy space available to developing countries by originating from them. In the crucial to gain knowledge and accumulate pro- strengthening the overall level of enforcement, absence of protection, due to duction and technological capabilities (Chang, and by eliminating exceptions or demanding the characteristics of knowl- 2002). Under the agreement, however, develop- commitments not included in the multilateral edge described in Section ing countries still enjoy some flexibility, mainly agreements ratified under the WTO. Overall, 3.2.2, other entrepreneurs would be able to use that granted through two mechanisms: compulsory measures included in regional trade agreements knowledge, replicate their licensing and parallel imports. With compulso- are often more stringent than provisions under innovations, re-sell them at ry licensing, authorities can license companies the multilateral trade regime. This is why they are lower prices and thus profit other than the patent owner to make, use, sell to often referred to as “WTO-plus” (e.g. they stipu- from these innovations. the domestic market, or import a product under late additional tariff reductions), and/or they go patent protection without the permission of the beyond current multilateral agreements and are 95 The firm that applies patent owner.95 With parallel imports, countries referred to as “WTO-extra” (e.g. they include ad- for the licence should have can import branded goods and sell them with- ditional provisions on environmental standards previously tried to directly negotiate a voluntary licence out the consent of the owner of the trademark. or rules of competition). Moreover, regional trade with the patent holder, un- In addition to these two principles, adapting agreements tend to provide fewer exemptions less there is a national emer- imported technologies to local conditions is al- compared to TRIPS and TRIMS. For example, in gency or extreme urgency, or lowed thanks to the granting of narrow patents TRIPS-plus commitments, regional trade agree- for public non-commercial for incremental innovations that build on more ments often prohibit the use of parallel imports use, or in cases of anti-competitive practices. fundamental discoveries.96 and allow compulsory licensing only in emer- gency situations. Furthermore, regional trade The General Agreement on Trade in Services agreements have pushed for harmonization and 96 For more in-depth treat- (GATS) extends the most-favoured-nation and mutual recognition of standards and technical ment, see also Correa (2015) national treatment principles (see Box 21 for regulations in order to remove technical barriers and UNCTAD (2007c). For the impact of TRIPS on measures definitions) to trade in a wide range of services, to trade and reduce transaction costs for foreign against climate change, see such as finance, tourism, education, and health. firms. In the context of promoting industrial de- Fortunato et al. (2009). The agreement allows countries to make a list of velopment, this means that domestic firms would activities that they commit to liberalize, as well face greater competition at home (because entry as the mode and sequencing of “opening up” in their domestic market is now easier for foreign

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module 97 97 Industrial policy: a theoretical and practical framework to analyse and apply industrial policy investment agreements. when signinginternational industrial policypriorities space and preserve countries' to safeguardhow policy See UNCTAD (2011c)on 114 2007, 2014b). (Calcagno,finance domestic 2015;UNCTAD, 2003, regulate to space policy the restricting and FDI) a selective approach to capital inflows (including services, impeding financial of deregulation and flows capital of sorts all of liberalization full for call oftenagreements addition, these system).In banking the of restructuring and management exchangerateto regardwith (e.g. policies nomic macroeco- or policies energy as velopment,such de- to related policies for compensation obtain and governments sue to investors ternational in- allowed have mechanisms Such investment. foreign the of profitability the affect might that of risdiction foreign arbitration centres on issues settlement”mechanism, ju- the countries accept Forexample,the through “investor-state dispute countries.developing of space policy the restrict agreements investment these that argued been be included in bilateral investment treaties. It has Alternatively,policymaking.can provisions these domestic affects implicitly that and vestment, in- foreign and markets capital of functioning the on rules imposes that chapter”“investment an include also can agreements trade Regional ity orenvironmental standards). qual- stricter with comply to have they (because investors) and to obstacles enter foreign markets ments have used specific industrial policy- instru In this regard, the module described how govern- failures.government of risks potential reduce to order in implemented and designed effectively be can policies how explaining policies, dustrial in- against and favour in arguments main the schools and interpretations. has also discussed It different between divergences the highlighting policy, industrial on views main the presented has It transformation. structural indus- in policy of trial role the examined has module This Conclusions 6 97 • • • • • • this moduleinclude: keyThe messagesof the internalbetween andexternal factors. economies,developing in policies differentiating industrial to challenges important most the of some discussed module the Finally, industries. local by catch-up successful support to ments industrial policy. condition can that agreements investment and trade bilateral, and regional especially but multilateral, from resulting space policy reduced China;a RepublicPeople'sof and the skills and knowledge requirements; the rise of their environment:GVCs,with economic and political international the from account challenges into take to developing needs also in economies policy industrial Successful bureaucrats and officials. efficient and competent with institutions strong and instruments policy of mix well-crafted a require policies dustrial in- successful that shows evidence Empirical middle-income economies. and industrialized of number a in successful proved have that instruments policy industrial some are there concerns, these Despite government failures. entailpotentialthey of number a as risks and implement,to easy not are policies Industrial are implemented inpractice. policy relateto how mainly industrial policies industrial against arguments while scale, of concepts such as externalities and economies economic on rely they i.e.theoretical, mainly are policy industrial of favour in Arguments should looklike. policy industrial optimal an what policy,and such of terms in done have economies alized - industri successful what is, policy industrial presentingtions differentvery what viewson tradi - different in authors with topic, versial controrather- a been have policies Industrial Industrial policy: a theoretical and practical framework to analyse and apply industrial policy

Exercises and questions for discussion 2 Question for discussion No. 1: What is industrial policy? module (a) Two groups of students (3-4 students each) debate the different definitions of industrial policy discussed in Section 2.l.

(b) Each student chooses an industrial policy instrument and discusses how it affects the economy and how it can be classified, following the classification proposed in Section 2.2.

• What does the expression “carrots and sticks” refer to? • What does “embedded autonomy” mean? • What is the main advice in the literature with respect to industrial policy design and implementation, and management of state-business relations?

Question for discussion No. 2: Arguments in favour and against industrial policy

(a) Each student picks one of the strands of literature summarized in Section 3.1 and explains its interpretation of the East Asian experience, taking into account the cases of other developing regions. Based on the East Asian experience, which policy elements would you recommend, and why, to developing countries that seek to industrialize?

(b) After reading Sections 3.2 and 3.3 students should answer the following questions:

• What are market failures? • What are economies of scale? Provide examples of how market failures arise in the presence of economies of scale and what the government can do to fix them. • What are externalities? Provide examples of factors that give rise to externalities and explain how and why market failures occur and what the government can do. • What are the factors that lead to imperfections in capital markets? • Discuss the infant industry argument. • What are the main arguments against industrial policy?

(c) Two groups of students (3-4 students each) debate the merits and relevance for developing countries of arguments in favour and against industrial policy.

(d) Each student chooses an industrial policy instrument and discusses how the use of that instrument can be justified and criticized, using the arguments reviewed in point (b).

Case study No. 1

Each student chooses one of the roles of the state outlined in Section 4 and identifies and discusses a policy experience of a country of the student’s choice in that particular area.

Question for discussion No. 3: Challenges to industrial policy in developing countries

(a) Two groups of students (3-4 students each) pick a country and discuss which of the internal conditions described in Section 5.1 are most relevant to the selected country and how they affect industrial policymaking.

(b) After reading Chapter IV of UNCTAD (2013b) and Farfan (2005) students should:

• Discuss and provide examples of the main forms of industrial upgrading in GVCs. • Discuss the factors that impede or facilitate upgrading in GVCs in developing countries. • Take one of the case studies on upgrading in commodity-dependent economies presented in Farfan (2005) and discuss the strategy and interventions used by policymakers to overcome commodity dependency. Do you think that the observed upgrading patterns could be replicated in other commodity-dependent economies? Why or why not?

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module Industrial Industrial policy: a theoretical and practical framework to analyse and apply industrial policy 116 (e) (d) (c) (b) (a) for acountrytheir choice. of Specifically, they should: Students shouldwork, eitheronanindividual basisorinagroup, onacasestudy ofindustrial policymaking Case study No. • • (c) (e) Exercises andquestionsfor discussion within them.within capabilities GVCsits upgradeinto and itself insert country the help can that interventions policy Propose andaddress challenges. canmaximize opportunities that trial policies economies. Examine the opportunities and challenges arising from these relations and the possible indus- People'sthe countryEvaluate Republicand selected the emerging other relationsor the China of between ofindustrializationterms priorities,choices in ofinterventions,types etc. their justify and economy the for relevant most are that policies complementary and priorities Identify these policies. of the state and discussing the elements of industrial policymaking that contributed to the success or failure Analyse the industrial policies implemented in the recent past, distinguishing the different roles played by the level ofstatecapacity). to attentionticular 2.3, par Sections constrainwith in factorsand the 5 discussed and 3.3 interventions policy of terms (e.g. in Assess the industrialization possibilities for the economy and identify the challenges and factors that may and investment agreements? trade bilateral and regional in included “WTO-plus”of “WTO-extra”and measures meaning the is What theseagreements?countries that enjoyunder the flexibilities are what And agreements? multilateralWTOthe by prohibited are interventions selective of types What After reading Chapters V and ofUNCTADVII (2014b), studentsthe following shouldanswer questions: international scenario? public of China as a global superpower. Which industrial policy can help the country frombenefit this new Re- People's the of rise the by affected is economy its how discusses and country a chooses student Each 2 - Industrial policy: a theoretical and practical framework to analyse and apply industrial policy 2 ANNEX type development. This dense local institutional structure was critical to the re-emergence of the module Industrial policy at the local level Mittelstand (medium-sized enterprises), which in many important respects lay at the heart of then Until relatively recently, the central government Federal Republic of Germany’s post-war econom- was portrayed as the driving force behind indus- ic performance. As in post-war Japan and Italy, trial policy design and implementation. Howev- therefore, the state of the then Federal Republic er, as Bateman (2000) notes, a good number of of Germany based its post-war development on industrial-policy-led successes have been under- pro-active regional and local state administra- taken – that is, designed, financed, implemented, tions that were able to develop capacity and gen- and monitored – at the sub-national level, involv- erate the local resources to promote recovery and ing combinations of pro-active municipal and re- development from the bottom up. gional governments (albeit often achieved with a helping hand from central governments). The Regional support for small and most important difference between central and medium-sized enterprises in Italy local industrial policy measures lies in the scale of the enterprises supported. Rather than focus- Italy is often held out as one of the countries ing on large enterprises, the emphasis of local that have shown considerable effort to promote industrial policy is mainly on promoting a thriv- the concept of local industrial policy. After 1945, ing, technologically forward-looking, innovative, the Italian government set out to support SME networked (both vertically and horizontally), and development through numerous financial sup- growth-oriented SME sector. This objective is import schemes. Of particular importance was the portant not only for employment, but also for in- Artisan Fund dating from 1947, which provided novation (see Section 4.2.2). 10-year loans at low interest rates for equipment purchases and the modernization of workshops. The examples of the then Federal Republic of Ger- In just over 20 years (1953–1976), the Artisan Fund many, Italy, and the People's Republic of China il- granted over 300,000 loans. However, the vast lustrate this point. Networks and subcontracting bulk of these loans (nearly 90 per cent) went to in supply chains and collectively owned enter- the northern regions of the country, where local prises also proved to be important policy areas and regional governments had established a very at the local level. effective set of institutions capable of granting these loans on the basis of an industrial policy. Regional support for small and The result was that nearly 36 per cent of all small- medium-sized enterprises in the then industry-based enterprises in the northern re- Federal Republic of Germany gions received one or more Artisan loans in this period. Between 1951 and 1971, the Artisan Fund The then Federal Republic of Germany rose from extended nearly 172,000 loans, while the increase almost total destruction in 1945 to become an in- in the number of enterprises totaled 226,700 – dustrial powerhouse and one of the world’s lead- meaning that the number of loans amounted to ing industrial export nations by the 2000s. The nearly 75 per cent of total sectoral growth. A very key to its transformation was an industrial policy large portion of the loans went towards capital approach built around a decentralized regional equipment imported from abroad, including state-owned institutional support system that from the United States. This equipment served to included banks, industrial R&D entities, technol- upgrade the level of local technology in a short ogy development institutions, training institu- period of time (Weiss, 1988). tions, and enterprise development entities that gave support both to create and later sustain In 1950, the government also established a loan industrial enterprise success (Meyer-Stamer and scheme to be administered through the Medio- Wältring, 2000) The regional (Länder) govern- credito Centrale that was specifically directed ment institutions were especially strong and towards more innovative small manufacturing motivated to promote the reconstruction and enterprises. As with the Artisan Fund, a very high industrial development process, financing key proportion of these enterprises accessed these enterprises and sectors based on careful techni- loans. But again, enterprises located in the north- cal studies and growth forecasts for the proposed ern regions were the main beneficiaries. The main market. The Länder and local governments were reason for the huge disparity in loan applications both instrumental in establishing and regulat- and approvals between the north and south was ing a wide range of support structures that could not differing economic pre-conditions and busi- promote SMEs through technology use, innova- ness opportunities – many of the northern re- tion, product and process upgrading, and proto- gions in 1945 were just as poor and devastated

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module Industrial Industrial policy: a theoretical and practical framework to analyse and apply industrial policy 118 their own to funds promote a local industrial pol- ly pro-active and, among other things, free to raise showed that the local governments were relative- economy.Chinese the (1992) Oi and (1991) Blecher of transformation economic the for impetus the provide to combined that policies industrial of local governments and cities to introduce a range pro-active for way the opened that 1980s the in the since early 1980s was also the achievedresult of decentralization China of Republic People's the of transformation structural remarkable The in enterprises Regional to establish alocal industrial policy. national governments aroundthe world wanting sub- other for model role the as serve to began model Emilian the of success manifest1970s, the the sector.By SME and microenterprise oriented building a flourishing innovation-driven, growth- of goal its operations,achieved its ERVETfor port sup- financial secure providing Emilia-Romagna mous industrial districts. With the government in and SMEs, including those operating within its fa- industrial clusters of innovative microenterprises ERVET has provided critical support to the region’s Located in Bologna, the capital of Emilia-Romagna, Agency). Development Regional Emilia-Romagna or Territorio Economica, Valorizzazione Romagna the of well-known most The Ferrari). (e.g. companies nology-based tech- prestigious most and largest the of some and SMEs for industrial world’sleading the location of many the as known became it and reali, alone totalof Italianthe of cent per 15 supported region Emilia-Romagna The industrial upgrading. and transformation structural local promote pro-actively to placed well were regions the mid-1990s, a third of Italy’s total, the northern support growth-oriented industrial SMEs and and SMEs.of 40 clusters of total a With SMEs industrial growth-oriented support to governments local and regional by tablished es- agencies development economic local were Italy’s northern example, final a As and Giacchè, 1970). growth technologicaland sophistication (Peluffo SME spectacular via achieved success economic regional of Italy”phenomenon “Thirdthe of rise the to contributed much very – technologies art by key localstate-of-the-the latest enterprisesto access tofacilitate support financial significant including crucially – sector enterprise local the This high levelfor of the support development of regional, provincial, and municipal governments. the by established institutions support state-led local and regional sophisticated highly and sive, comprehenwell-funded,- the but – south the as support the People's Republic ofChina

for Emilia- ( ERVET is reali servizi small and medium-sized by by reali servizi evz reali servizi servizi servizi tn i idsra dsrcs. motnl, t was it Importantly, districts”. “industrial in ating oper SMEs and firms large constituent between ed thanks to constant interaction and cooperation ery,tools,machine etc.were continually– upgrad - machin- textile textiles, – industries large where region England,a northern centuryeffect” 19th in Marshall (1890) first identified this “agglomeration benefits (informal transfer, knowledge etc.). Alfred other of range indirectly,a and,innovations, and technologies new knowledge, technical labour, skilled inputs,intermediate quality provide rectly embedded within a dynamic SME sector able to di- observed that large enterprises operate best when onwards, mid-1800s the scholars chains.From ply sup- subcontractingin and networks consider we if pronounced more even is transformation tural - struc in policy industrial local of importance The Networks andsubcontracting insupplychains novationto rapidly inorder improve quality. in- and R&D local stimulating and specifications, technical high required that items subcontract to capacity the SMEswith of required cluster the ing involved in the selecting foreign partners, promot ing a major automobile industry. City officials were Shanghai,particular,in develop- in pro-activewas real ment that level weretaken.actions The city of govern- local the at was it industry, but tomobile au- domestic a of emergence the see to keen all clear,makes (2006) As were Thun leaders political automobiles. to regard with state”is tal approach what came to be known as the “local developmen- of example best the Perhapsics,engineering. and centredshipbuilding, electronon - sectors dustrial governments were to able build world-beating in- city many government, national the of support the scratch.fromWith industries whole establish to movedbegin awaythe to from experiment TVE then governments local successful most and est internal larg- TVEs.the The and privatize to mounted pressure external time, Over 2000). (Qian, entrepreneurship” “municipal of experiences ful success- most the of one probably representing (O’Connor,China of RepublicPeople's the in 1998), TVEs industrial million 7.6 some were there 1996, By expand. to order in possible as technology art state-of-the- much as conuse - to pushed and straints budget government-owned hard under local operating enterprises were enterprises which village and (TVEs), township for involved governments support by local moves first The tral governmentto avoid inorder over-capacity. cen- the by mediated competition inter-locality locality,the of forma stimulated of turn in which advancement economic successful on depended bureaucracy state Chinese the within seniority that was here factors motivating the of icy.One - - Industrial policy: a theoretical and practical framework to analyse and apply industrial policy 2 found that dynamic local governments and city gional governments establish a comprehensive administrations stood behind many of the crucial support structure for local industrial microen- module institutional innovations undertaken to establish terprises and SMEs that can resolve almost all of and expand these industrial districts, such as in their main financial, training, technical, and tech- basic education and technical vocational educa- nology transfer problems. tion and training, technology transfer, new product and process generation, and public procure- Collectively owned enterprises ment. Agglomeration effects are a crucial factor in achieving productivity increases and structural Collectively owned enterprises are also positively transformation from the bottom up. Importantly, associated with important episodes of local and local industrial policies can link microenterprises, regional structural transformation. Cooperative SMEs, and large enterprises in such a way that, enterprises have a long history of innovating among other things, knowledge and skills flows and promoting industrial development in areas are spurred, technologies transferred both up in which conventional privately owned compa- and down the supply chain, and risks and rewards nies, or even the state, are unlikely to invest. One shared in an atmosphere of trust and cooperation example concerns the Mondragon Cooperative based on a strong identification with the health of Complex, a network of almost 120 worker coop- the local community. Several examples illustrate eratives that was established in the small town the important potential here. of Mondragon in the Basque country of northern Spain. Mondragon houses a network of worker For example, much success in the then Federal cooperative enterprises (Ellerman, 1982). Cata- Republic of Germany was achieved in supporting lysed into life in the 1950s by a Roman Catholic the medium-sized enterprises (Mittelstand). But priest who wanted to address the town’s high the wider, less-publicized success was in creating unemployment and poverty rates, the Mondrag- a highly efficient supply chain involving SMEs on cooperative complex began with one worker supplying highly specific inputs to major com- cooperative making simple industrial items for panies operating in the automobile, electron- sale in the locality and wider region. It eventually ics, engineering, and other industries. Similarly, grew to become one of the world’s leading inno- the industrial policy approach in northern Italy vative companies, while retaining almost all of its post-1945 was also very much developed around original cooperative philosophy and structures. support for highly productive local enterprise Early on, the municipality realized that growth networks and clusters that provided quality in- (and thus jobs and incomes in the community) puts to a new generation of Italian corporations. was likely only if there was an industrial policy In addition, many of the supply chains supported framework that could offer dedicated support were composed of solidarity/equity-promoting to industry-based worker cooperatives. Accord- cooperative enterprises, a preference that helped ingly, the Mondragon community began by put- build up important further reserves of trust, reci- ting together a wide range of industrial policy procity, and cooperation in the local industrial interventions including a financial support co- community (Zamagni and Zamagni, 2010). operative offering low-cost capital (the Working People’s Bank or Caja Laboral Popular), a high- Alternatively, Japan established a local supply quality technical advisory and business support chain model that some scholars describe as the body (the Entrepreneurial Division or Empre- core factor behind Japan’s post-war industrial sarial Division), an applied research and technol- success and structural transformation (Fried- ogy transfer centre (Ikerlan), and a local college man, 1988). The essence of the Japanese local (Escuela Politécnica Superior) for industrial R&D supply chain model is the extent of cooperation and vocational education and training. A par- established between the large company at the ticular strength of the Mondragon cooperative top of the supply chain and the industrial mi- complex was the ease with which innovations croenterprises and SMEs in the local community and tacit knowledge were passed around the that supply it. In contrast with industrial develop- group, greatly contributing to upgrading tech- ment models in the United States and the United nology in all of the Mondragon groups’ products Kingdom, in Japan a leading company’s coopera- and processes. Recognizing the great success of tion with suppliers is typically long term. A mini- the Mondragon industrial cooperative complex, mum profit is guaranteed to suppliers, risks are the Basque regional government began to con- shared, and financial, technical, and other forms struct an industrial policy framework along the of support are made freely available to suppliers same lines in the 1970s. After some setbacks, this by the leading company (Nishiguchi, 1994). One framework has transformed the region from one obvious case in point is the automobile industry of Spain’s poorest in the 1960s into one of its rich- (Womack et al., 1990). For their part, local and re- est regions (Cooke and Morgan, 1998).

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