## The Return of Industrial Policy

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### Geopolitical shift and trade policy context
- Geopolitics is rapidly changing the landscape of world trade; the policy environment of the 1990s and 2000s is described as a distant memory.
- The reform period of the 1990s and 2000s featured market opening, globalization, and the creation of the World Trade Organization’s rules-based system of nondiscriminatory trade.
- Recent trends: rise in industrial policies and subsidies, import restrictions on national security and environmental grounds, and export controls to punish geopolitical rivals and secure domestic supply.

### Historical debate over industrial policy
- Mid-20th-century arguments favored import substitution and self-reliance for low-income countries, driven by fears of declining terms of trade and rising inequality.
- Misreading of history: protectionist policies in the United States coexisted with openness to immigration, capital, and technology; US overtook Britain in per capita income in the late 19th century by increasing labor productivity in the service sector rather than manufacturing.
- In Western Europe, growth related to shifting resources out of agriculture into industry and services; protection of agriculture likely slowed that transition in some countries.
- East Asian experience nuanced:
  - South Korea in 1960: exports of just 1 percent of GDP; dependent on US aid.
  - After devaluation in the early and mid-1960s, exports reached 20 percent of GDP by the early 1970s.
  - Korea’s main policy was a realistic exchange rate and cheaper credit for all exporters; targeted industrial policy came later with the Heavy and Chemical Industry Drive of 1973–79, which was later terminated for excessive costs and inefficiency.
- Quantitative models suggest gains from even optimally designed industrial policies are small and unlikely to be transformative.

### Recent major economies embracing industrial policy
- China:
  - Shift under President Xi Jinping toward greater state control and away from Deng Xiaoping’s outward orientation.
  - Made in China 2025: large subsidies to targeted industries.
  - Dual circulation: reduce external dependence by strengthening domestic sourcing and pursue self-sufficiency in key technologies.
  - Example: 2006 identification of shipbuilding as a “strategic industry,” followed by massive production and investment subsidies mainly through cheap loans; outcomes described as wasteful (excess capacity), market distortion, political allocation to state-owned enterprises, limited spillovers, and no evidence of industry-wide learning by doing.
- United States:
  - Began protecting steel and aluminum on national security grounds during the Trump administration.
  - Adopted CHIPS Act and the Inflation Reduction Act with subsidies to “reshore” semiconductor production and restrictive national content regulations for electric vehicles to ensure domestic production.
- European Union:
  - Longstanding industrial policies; announced in 2020 an industrial strategy to enhance “open strategic autonomy” in the green and digital transition.

### Risks and limits for developing economies
- Large-scale industrial subsidies are characterized as a luxury affordable to rich countries but risky for fiscally strapped developing economies.
- Risks identified:
  - Subsidies could be expensive with elusive benefits.
  - Trade restrictions risk inward protectionism, reduced export earnings, and shrinkage of critical imports.
  - Political allocation of support to inefficient state-owned enterprises can dissipate subsidy benefits.
- Policy caution quoted from Ricardo Hausmann: “Copying other countries’ solutions to problems you do not have, or focusing on trendy issues that are not really important, is a recipe for inefficiency, if not disaster.”
- Fiscal recommendation: scarce public funds may be better spent on health, education, and helping poor people rather than on subsidizing domestic industries.

### Evidence on trade openness and development gains
- China’s broad growth attributed to improving agricultural productivity, allowing foreign investment in manufacturing, and unleashing the private sector—not primarily to industrial policy.
- India’s 1991 reforms dismantled the “License Raj” and opened the economy, continuing to propel growth though more reforms are needed.
- Bangladesh benefited from opening to foreign investment, raising per capita income above India’s.
- Other countries (example list in text: Ethiopia, Vietnam) achieved more from engagement than isolation by gaining technology and investment from the rest of the world.
- The openness of the reform period around 1990 led to convergence between rich and poor countries, reversing the historical norm of divergence.

### Conclusion and policy recommendation
- Globalization is changing, not dead.
- Developing economies are advised against returning to closed-door policies and large-scale industrial subsidies and trade restrictions.
- Recommended stance: continue supporting exports and acquiring technology from beyond borders; avoid inward turns that sacrifice gains from global economic engagement.

*Douglas Irwin, “The Return of Industrial Policy,” Finance & Development, June 2023.*

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_Source: https://www.imf.org/-/media/files/publications/fandd/article/2023/june/irwin.pdf_