Don’t Be Afraid to Compete: The Role of Industrial Policy in Global Development
Do economies always grow fastest when left alone, or can governments spur economic development through active measures such as subsidies? What kinds of interventions – also known as industrial policy – are most effective?
These questions motivated a lecture delivered by Dean Ann E. Harrison of the Haas School of Business at the University of California, Berkeley. Dean Harrison, an award-winning economist with experience in both academia and the World Bank, gave her talk as the 2021 Paul Streeten Distinguished Lecture on Global Development Policy. This annual event celebrates the legacy of Boston University Economics Professor Paul Streeten, who contributed greatly to the study of development and to Boston University.
Dean Harrison began her talk by reviewing how rare it is for countries to move from low- to middle-income status, or from middle- to high-income status. Of countries that have experienced sustained rapid growth since 1990, she noted, most have been located in East Asia and made use of some form of industrial policy. However, whether industrial policy played a key role in accelerating this growth, or whether development occurred in spite of these policies, has remained an open question.
Even opponents of industrial policy recognize its theoretical potential to overcome market failures. Dean Harrison gave the example of latent comparative advantage, in which an industry might not be globally competitive at a small scale, but could succeed once it had attained a certain size. However, identifying latent comparative advantage is difficult, and various forms of “government failure,” such as backing politically-connected firms can actually retard growth, leading some critics to argue that the cure of industrial policy can be worse than the disease of market failure.
To these practical and theoretical debates, Dean Harrison brought several examples of cutting-edge empirical research. Beginning in 19th-century France, she described how Napoleon’s Continental System was a form of incidental industrial policy, serving to stimulate investment in the yarn-making industry by cutting off the source of inexpensive British imports. Remarkably, patterns of investment sparked by this policy were self-sustaining, and the geographic distribution of the yarn industry in France remained stable for the following 100 years. This example illustrated the potential for such interventions to have deep, long-lasting influence.
To uncover the reasons behind why some forms of industrial policy are more effective than others, Dean Harrison turned to contemporary Asia. In brief, she declared that government interventions are growth-promoting when they serve to increase competition, either by assisting entry into the domestic market of new firms, or by helping existing firms to enter export markets. Policies that limit competition, such as tariffs, instead often result in lower productivity.
As an example of successful, competition-promoting industrial policy, Dean Harrison pointed to China. In research with coauthors, she found that regions and industries where subsidies were distributed among many firms grew faster than those where the government had “picked winners” and concentrated subsidies among a small number of firms. An even more recent example, she noted, is “Operation Warp Speed,” which accelerated the production of vaccines for COVID-19 by making US government resources available to many firms and putting them in competition with one another.
As an example of unsuccessful, competition-inhibiting industrial policy, Dean Harrison discussed India’s since-abandoned practice of reserving market share for small and medium-sized enterprises. When this policy was abandoned, the harm done to incumbent firms (measured by several outcomes, including wages and total economic activity) was greatly outweighed by the benefits to large new firms. This touched on another characteristic of successful industrial policy: having a clearly defined end date, which incentivizes firms to make the investments necessary to eventually compete without government support.
Having established that industrial policy can accelerate development and that governments can make informed decisions about which interventions are most likely to be effective, Dean Harrison concluded by speaking about the most important future application: climate change. She described climate change as “the biggest market failure in human history” and outlined key lessons for governments: tailor solutions to the strength of local institutions (to avoid “government failure”), adopt high performance standards that encourage innovation without picking winners, and to seek a tight link between policy instrument and economic problem. On this last point, she lamented that the most economically ideal solution to climate change, a carbon tax, was rarely adopted. Efforts to address two problems with a single instrument, such as wind turbines as a solution to climate change and underemployment, are also vulnerable to becoming a suboptimal solution to both.
These inefficiencies attest to the difficulty of implementing industrial policy successfully. However, Dean Harrison concluded her talk by asserting that the era of reflexively choosing to rely on the invisible hand of the market over the visible hand of government was over, and that societies were likely to try to find an appropriate balance as they confront the challenges of the 21st century.
James Sundquist is a Global China Initiative Fellow at the Global Development Policy Center and a doctoral candidate in political science at Yale University. His dissertation research explains variation in narratives of China’s rise, while a second body of research centers on China’s loans to foreign governments.
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