Making Industrial Policy Work

GENEVA – Industrial policy (IP) is back – or rather, back in fashion. Of course, it never really went away, even in countries formally adhering to free-market principles. But the post-crisis world – in which government intervention in the economy has gained greater legitimacy – will see more of it. Likewise, China’s success, and the temptation to bandwagon on its development model, has reinvigorated IP’s appeal, as have better policy tools and greater experience of what works and what doesn’t – a point well argued by Justin Lin of the World Bank.

Indeed, a debate in The Economist last year, led by professors Josh Lerner and Dani Rodrik of Harvard University, ended with 72% of voters expressing faith in the merits of IP. Policymakers seem to be of the same opinion, and not just in developing countries, judging by the EU’s launch of its 2020 flagship last year and the United States’ green energy policy.

But, for developing countries, the old dangers of IP continue to apply. First, policymakers often get it wrong, both when picking which industries to support and in implementing support mechanisms. Second, policymakers are prone to “capture” by vested interests, especially in relatively weak policy environments, leading to favoritism, inefficiency, and waste.

Moreover, compared to IP’s previous Golden Age, there are several new risks nowadays. The first concerns the temptation to follow China’s lead unquestioningly. Policymakers must recognize that the Chinese model includes features peculiar to its gradual introduction of market mechanisms – which, compared to IP’s new converts, represents a move in the opposite ideological direction.