Why does industrial policy (so often) fail?

In response to my post on China, Bert Hofman of the World Bank writes to me about Indonesia's local content requirements and how they have not achieved anything like China's success. He speculates:

Of course, Indonesia is different than China.  But one of the thoughts I had was that the main differences are size of the market and local competition.  Even a
country such as Indonesia may not have the scale to make these programs a success, whereas in China the market and the domestic competition is large enough
to use industrial policies such as local contents requirement.  The scale of the market promises learning effects, and domestic competition makes them reality.

Possibly. But I think a more important determinant of the success of industrial policy is the willingness of the government to monitor the results and change its policies as needed. Most industrial policy successes I know are the outgrowth of programs that produced poor results initially. Governments had to fine tune them in light of what they learned. A government too close to the industry cannot effectively do this, since the incumbent beneficiaries of the failed policies can block the changes. This is clearly one reason why the Indonesian program failed. But a government that simply watches from afar and keeps firms at arms' length does not accumulate the evidence to be effective either. What is required for the government is something in between--embedded autonomy, to use a term coined by the Berkeley sociologist Peter Evans.

Comments

[Kenji]

What is your take on empirical studies that show that industrial policies often have a neutral or often negative impact on total factor productivity? I thought that China's success had everything to do with mobilizing underutilized labor and capital?

[crack]

Is it possible that in instances of successful industrial policy occur when the Government acts as sort of a board of directors?

[Joe]

I agree with the arguments of Prof. Rodrik. In Indonesia, during the Suharto era, one could hardly distinguish the government from the private industry (most businesses were funded by the President's trust!). True, the fact that nearly 70% of the organized manufacturing was controlled by four conglomerates speaks volumes of the degree of domestic competition. However, this may indeed be a good thing in the early stages of industrialization when resources are scarce and markets are small (This was clearly the thinking behind the industrial licensing policies in both Japan and South Korea). But, I think, the key missing element in Indonesia's industrial policy until the mid-1980s, compared to China or Japan or South Korea, was a lack of emphasis on manufacturing exports (perhaps due to the smooth inflows of foreign exchange generated by the oil and gas industry). China, in contrast, has seen mostly export-oriented foreign investment, which meant that quality considerations were paramount with regard to local supplies (and therefore greater transfer of technology from MNCs to domestic industry and greater learning efforts by the latter).

[Robert P.]

"A government too close to the industry cannot effectively do this, since the incumbent beneficiaries of the failed policies can block the changes...But a government that simply watches from afar and keeps firms at arms' length does not accumulate the evidence to be effective either."

How does this relate to our private health care problems and at what level of intervention should the US government intervene with universal health care so as to not become too little or too greatly involved?

p.s. you should activate blockquote and italics in the comments.

[Gallagher]

Indeed, having policy space or even deplolying industrial policies will not automatically bring benefits. Industrial policy can help "get the prices right" but it won't be a success unless one gets the political economy right as well.

The three key elements of success are

1. placing the policy as "close" to the market failure as possible (See Rodrik, 1992 in World Development).
2. "Embedding" the policy-makers with the private sector (this is the Evans argument). This allows firms to "pick losers" less.
3. "Reciprocity". Industrial policies need to be coupled with performance requirements to ensure innovation and that the majority of the benefit does not go to rent seeking (see Alice Amsden, The Rise of the Rest, 2001).

[jonfernquest]

"But I think a more important determinant of the success of industrial policy is the willingness of the government to monitor the results and change its policies as needed."

A stunning example of this has to be Park Chung Hee's Heavy Industrialisation Drive of the 1970s. Of course, there's a horrible human rights side to it too, that people wouldn't ignore as readily now as they did during the Cold War. Several friends in the offshore construction industry told me how deep government monitoring and control (KCIA too) was in that ministry. Also my favorite Korean poet, imprisoned and emasculated by electrocution. Mentioning Park Chung Hee's name in a Korean university classrooms was certainly to evoke extreme and polarised emotions when I taught there in the 1990s. Peter Evans treats the Korean case as I remember, but Bruce Cumings "Place in the Sun" strikes the right balance between raw economics and the human side, also:

Clifford, Mark L (1994) Troubled tiger : Businessmen, bureaucrats, and generals in South Korea

Woo, Jung-en (1991) Race to the swift : state and finance in Korean industrialization

Yumi Horikane (2005) "The Political Economy of Heavy Industrialization: The Heavy and Chemical Industry (HCI) Push in South Korea in the 1970s," Modern Asian Studies 39, 2. [Superb historical detail on human agency side, based on PhD dissertation work]

[Shiela dela torre]

I could only relate to the classic linear stages of growth model of Rostow and Harrod-Domar to understand why industrial policy fail in most developing countries.

It would appear that the assumptions on the stages of growth model that with savings and investment a take-off period may be experienced by a nation remains to be a myth. In fact, the World Bank in 1998 claims that the poor economic performance of developing countries is not only a result of a financial gap but by an institutional gap, and I believe this is a major constraint of our country, the Philippines, and where the present Administration is focusing on major reforms in key areas on fiscal administration; trade and investments.

[crack]

Would Singapore be considered as successful Industrial Policy? Its tiny, has no resource, and virtually no domestic market. The government has a stake in many of it's successful enterprises.

[gordon]

All fascinating stuff, but I confess to a degree of scepticism about a lot of cross-country research - there are too many differences between countries to make the results of such work always convincing. I would be more interested in within-country research focussing on how policy changes over time are reflected in economic outcomes.

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