From Paradigm Maintenance to Paradigm Shift: A Mood Change on Industrial Policy
Last month, the World Bank announced the return of Industrial Policy for Development in a report described as “the first comprehensive guide to industrial policy for development in the 21st century.” Running well over 250 pages and covering 15 policy tools, the latest edition concludes that industrial policy should be given its rightful place in the development policy toolkit and offers a strategic guide to how and under what conditions it works.
The Bank has made previous forays into this territory. In the early 1990s, under pressure from the government of Japan, but against an ideological tide pulling the Bank in a “market friendly” direction, The East Asian Miracle report examined the role of industrial policies in the region’s success. While acknowledging that such policies had played a positive role, the Bank insisted they were not a replicable (or desirable) option elsewhere in the developing world. It argued that the only route to prosperity was getting relative prices right through competitive markets, responsible macroeconomic policies, a sound financial system, and economic openness. Development scholar Robert Wade dubbed the report an exercise in “paradigm maintenance.”
Some years later in 2012, Justin Yifu Lin, the first World Bank Chief Economist from a developing country, proposed “new structural economics” as a framework to shine a more positive light on industrial policy. The moment seemed opportune, with the limits of the Bank’s neoliberal approach highlighted by the global financial crisis and China forging ahead with its policy-induced industrialization drive while other developing countries were calling for help to escape a “middle-income trap” and “premature deindustrialization.” But Lin’s idea that industrial policy was best employed to nudge a country’s comparative advantages did not gain traction and the attention of the Bank remained firmly fixed on their “billions to trillions” agenda, pushing “public-private partnerships” to raise the trillions of dollars needed to finance the Sustainable Development Goals (SDGs).
This time does seem different, however. The “billions to trillions” agenda has failed to deliver, and developed countries have turned to industrial policy in a search for greater resilience against multiple shocks while China has successfully shifted policy gears in support of technologically cutting-edge sectors. In response, the Bank’s new report offers a more whole-hearted embrace of industrial policy to advance economic diversification, enhance economic security and manage new technological challenges. Moreover, the report insists that state capacities in developing countries are now at a level to allow for the wider adoption of targeted policy support.
Rather than litigating past experiences, the report instead focuses on 15 policy instruments required to correct market failures that could otherwise stymie the development of strategically important business activities. These instruments are allocated into three broad categories: public inputs tailored to specific industry needs; market incentives to encourage a specific activity; and macroeconomic interventions that broadly incentivize industrial policy goals. The report offers a rich review of the recent literature and an array of illustrative case studies with the aim of identifying when best to use one or other policy type, their possible combination, the difficulties with targeting and the challenges around correcting policy failures.
Readers will no doubt raise specific questions about the evidence offered— such as the insufficient attention to how China has successfully deployed industrial policies, and find substantive areas of disagreement—including the relation between the report’s market failure approach to industrial policy and one focused on structural transformation, which is raised but left unaddressed. Nevertheless, there is much in the report to move the discussion forward.
One area of the report in need of deeper reflection and development is its “feasibility framework.” Three constraints—fiscal space, market size and government bandwidth—are put forward as determining what types of industrial policy are likely to work best in a particular national setting. Various combinations of these constraints are examined and a typology of feasible policy tools is constructed. The report seems to suggest that these constraints are the product of what the head of the World Bank at the time of the East Asian Miracle study, Lewis Preston, called in his foreword, “non-economic factors.” But despite a passing reference to evolving characteristics and government agency, the feasibility conditions feel unduly constraining not least because they are themselves, in part, policy-determined.
A more discerning approach to the feasibility question should recognize that industrial policies cannot be introduced as stand-alone measures but as part of an integrated development strategy. Doing so no doubt adds complexity to the priority-setting agenda and managing the trade-offs therein. This in return requires more careful attention to matters of institutional leadership, alliance building and learning than offered in the report. It also involves delving a bit deeper into what is understood by development policy.
Soon after the Miracle study was launched, UNCTAD was given resources by the government of Japan to offer its take on the East Asian success stories. It concluded that these economies had all succeeded in building strong links between profits, investment and exports, establishing an industrial landscape populated by firms with sufficient scale advantages to compete on domestic and international markets. These economies also succeeded at developing strong regional ties, loosely understood along the lines of Japan’s own “flying geese” paradigm. Unlike the Bank’s study, UNCTAD concluded that industrial policies were still relevant to countries looking to build their development strategies around structural transformation and strategic integration with the external economy. Doing so implied a wider “feasibility framework” into which industrial policies could be situated and institutional capacities considered.
From this perspective, fiscal space is important but only as part of a wider agenda of domestic resource mobilization in which profits can be boosted by policy-induced rents and by directed and subsidized finance from national development banks, oftentimes with strong support from the central bank; on the latter issue the current report is a step back from the Miracle study. This wider approach also brings in “reciprocal control mechanisms,” whereby industrial policy provides not only carrots to the entrepreneurial class running large firms but provides the sticks to discipline their behavior, through the withdrawal of support or the threat of competition from new entrants, domestic or foreign.
Similarly, domestic market size, identified by the Bank with the size of the middle class, is only part of a wider set of demand-side conditions. Macro-financial policies play a crucial role in shaping these conditions as do distributional factors where the balance between wages and profits against a backdrop of shifting corporate governance and labor market institutions are a significant influence on the size and direction of market opportunities. But much like the earlier East Asian study, the current report pays little attention to the inequality challenge in the context of structural transformation.
Finally, the reduction of government capacity to its ability to interact with many businesses and industries at the same time (“bandwidth”) is perhaps the most disappointing part of the report given the vast literature that has sprung up since the Miracle study on the developmental state (and statecraft). The following issues will need closer attention if the aim is a fuller grasp of the political economy of industrial policy: voice and capture in shaping policy design; the politics of policy coordination across a set of interrelated challenges and associated agencies; and the challenges, at both the national and international levels, around policy space, including with respect to the World Trade Organization and trade architecture more generally.
Given the challenges facing developing countries, there seems little doubt of the need for a new development narrative beyond the Washington Consensus (and its subsequent updates). In this regard, the World Bank’s new report has opened a path from “paradigm maintenance” to “paradigm shift.” Following that path will face obstacles both within the Bank, where the slippage from research to operations is longstanding, and outside, requiring new alliances and networks with other development agencies, academia and civil society organizations. But this is a welcome first step.
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