Home Economy Industrial Policy Revisited: Levelling the Playing Field, Protectionism or Both

Industrial Policy Revisited: Levelling the Playing Field, Protectionism or Both

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Industrial policy is making a comeback among policymakers in advanced economies that long eschewed excessive state intervention. While state-led strategic policy intervention was always viewed as the key driver for the East Asian economic miracle utilised most notably by Japan and Korea, such intervention was (begrudgingly) accepted by the established order as a necessary but time-limited way of boosting economic development in a finite number of countries where certain conditions prevailed.  

China’s persistent use of state-intervention and export-oriented growth tested, strained, and finally cracked the limits of tolerance. While it was widely known that China would pursue such strategies when it entered the World Trade Organization (WTO) in 2001, the prevailing view among policymakers and academics was that the country would eventually shift towards a model based on domestic consumer consumption (not to mention accompanying political reforms) as it matured. This shift did not occur, and liberal economic democracies came to view China as a threat to their own economies as well as to the global system. China is now accused of not complying with the letter and spirit of its trade commitments, and the WTO criticised for not being capable of constraining China’s rise on the back of what some viewed as ‘gaming’ the system. China is also accused of using trade relations as a tool as it wields geoeconomic power.

But as the saying goes, ‘If you can’t beat them, join them’.  While industrial policy never quite went out of favour in emerging economies, what is striking is that the very countries that established the liberal international economic order have now decided that the system no longer benefits them – and the perceived solution is industrial policy. In a complete reversal of policy, the United States is leading the march away from the established rules-based system. 

The numbers back up the rhetoric. The International Monetary Fund reports that countries adopted more than 2,500 industrial policy measures in 2023, two-thirds of which were deemed ‘trade-distorting as they likely discriminated against foreign commercial interests’. While we could expect state-led economies like China to feature prominently on the list of new measures, the European Union (EU) and United States (US) also feature. In fact, those three jurisdictions account for nearly half of all the new industrial policy measures.

In the name of responding to and combatting ‘asymmetries in regulations, subsidies and trade policies’, the EU and US are implementing their own trade-distorting policies. Most notably, subsidies are flowing for traditional manufacturing such as automobiles and steel as well as renewable energy, electronic vehicle development and semiconductors.  Tariffs are being raised, whether via China-specific actions or through trade remedy measures seeking to combat ‘unfair’ trade, and supply chain resilience is encouraging a shift from ‘just in time’ to ‘just in case’ production as terms such as ‘decoupling’, ‘derisking’, ‘near-shoring’, ‘friend-shoring’ and ‘securonomics’ proliferate and become part of the policy vernacular. 

Lost in the quick shift to embrace industrial policy is that all such policies and measures are not created equally – they will have different effects and consequences. For example, there is a difference between policies that attempt to create growth and development by protecting domestic companies from foreign competition and those which help those companies grow and become more efficient. 

Some advanced economies are now utilising both strategies – trying to trip the competition (read: China) but also run faster. There are many problems with this strategy. For instance, shielding domestic companies from competition via tariffs or other barriers without the accompanying growth strategies is tantamount to import substitution. This tried and failed policy was widely utilised throughout the post-colonial period in Latin America, Africa and South Asia. Economies employing import substitution forced consumers to purchase inferior products at high prices supplied by inefficient, protected domestic industries, while at the same time the East Asian tigers were exporting their way to advanced economy status. Moreover, such policies also alienate trading partners. The very same partners that are critical to the success of de-risking from China via friend-shoring and near-shoring. 

By contrast, industrial policy that seeks to make industries more competitive can create sustained growth and economic development. But even there, there are limits. The conditions necessary to promote and execute an export-oriented growth strategy may not exist in every country. Moreover, such strategies require governments not only to promote the chosen industries but also to accompany the direct support with ancillary policies. For instance, the promotion of a certain industry would likely fail without liberalised investment and taxation regulations, lower barriers to imports of required inputs and an appropriate business climate. It is also questionable whether targeted export-oriented strategies can work in larger and more mature economies.

Another perceived issue is that competitive conditions have changed since Japan and Korea successfully implemented export-oriented growth strategies. Since its creation in 1995 as the successor to the General Agreement on Tariffs and Trade (GATT), the WTO provides for stricter disciplines on subsidies and other potential support measures.  But the WTO’s bark has proven to be bigger than its bite. Again, China has managed to utilise state-led development strategies to attract investment, boost and insulate domestic industries and become the world’s largest exporter of manufactured goods.

Make no mistake, the inclusion of larger, mature markets in the industrial policy game will make it even more difficult for smaller countries to successfully implement industrial policy. Such countries, both rich and poor, cannot compete against excessively subsidised goods on the world market or break into closed markets.  

World trade is becoming more fragmented as protectionism and nationalism trumps economic efficiency and market economics. The key may be not in attempting large-scale industrial policy initiatives but rather in focusing on harnessing existing strengths and areas of comparative advantage. This may be particularly important for developing economies.

Here we can lean on the insights of Justin Yifu Lin, a professor at Peking University and former Chief Economist and Senior Vice President of the World Bank. This is perhaps the central insight of Lin’s theory of new structural economics. What Lin is attempting to do is combine neoclassical economics and structuralism (the theory that led to import substitution) to produce a development economic theory that does not reject contemporary economic analysis but still remains sensitive to the specific circumstances of developing economies. The key to the theory is the nuanced take on government intervention. The theory does not presume, and seems to reject, that governments can be all-knowing or altruistic but likewise stresses the role of the state in development.

Governments can promote industralisation in a number of ways, ranging from providing information about new industries, coordinating investments across firms and industries, remedying informational externalities, promoting innovation-boosting measures, providing worker training and export credits, and through setting policies that encourage foreign direct investment and technology transfer. It is also important to note here that such a theory could apply not only to manufacturing sectors but also to services.

New structural economics differs from structuralist economics in that it is not seeking governments to fight against comparative advantage; rather, the theory stresses the central role of the market and the role the government could play in harnessing existing strengths so as to facilitate comparative advantage. This implies targeted support of select industries, rather than a widespread embrace of import substitution. While the line between what Lin is advocating and old-school structuralism can at times be blurred, the lesson is nevertheless important – offset market distortions and induce firms to make choices that harness the power of comparative advantage. 

Regardless of what industrial policy is utilised, it is important for governments to have a clear purpose and an overarching holistic policy. Most notably, is the policy seeking to exclude foreign competitors from the domestic market or to increase the competitiveness of domestic producers?  The industrial policy being embraced by many seems more scattershot than as part of a clear policy with identifiable objectives. This is a shame and guaranteed to produce more losers than winners.

Acknowledgement: The author acknowledges funding support by the Hong Kong General Research Fund (project no. 14609722) for a project entitled, ‘Engaging with China to Reform the World Trading System’.

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