What have economists learnt about using industrial policy to promote economic development?
Read "The New Economics of Industrial Policy" by Réka Juhász, Nathan J. Lane and Dani Rodrik here.
What is industrial policy? How can it be best employed to kickstart development. In this episode of VoxDevTalks, Dani Rodrik discusses what we know about the effectiveness of industrial policy, key lessons for policymakers in developing countries and the evolving policy agenda that it represents.
What is traditional industrial policy?
Industrial policy is often associated with the idea of "picking winners," where governments identify and support specific sectors for development. This approach has been used globally, with examples including import substitution policies in Latin America and export subsidies in Southeast Asia. Contrary to popular belief, industrial policy has also been central in the United States, even during the Reagan administration.
Why did industrial policy fall out of favour?
It's generally recognised that the fundamental reasons for industrial policy are very much present in developing countries such as large learning externalities or rampant co-ordination failures. However, industrial policy lost popularity, not driven by strong empirical evidence but by pragmatic concerns, including scepticism about the government's ability to intervene effectively or select successful sectors.
How has industrial policy changed over time?
Industrial policy is now being done in a 'self-conscious' way whereby political leaders, especially in the US are making clear statements about their use of industrial policy. However, its focus has shifted. While traditional industrial policy prioritised innovation, productivity, and manufacturing, contemporary efforts also emphasise supply chain resilience and investments in green energy.
New evidence and methods provides a more positive light on industrial policy
Early studies on industrial policy were primarily correlational and plagued by interpretational challenges, limiting their impact. Advances in empirical methods such as using historical or geographical accidents as natural experiments, applying instrumental variables and employing difference-in-differences (DID), have enabled more rigorous evaluations.
These advancements yield two key findings:
1. Long-term structural change: Government protection or promotion of specific sectors can drive enduring structural shifts in the economy.
2. Effective government intervention: Evidence shows that governments can successfully enhance capacity and employment within targeted sectors, supporting the case for strategic policy interventions.