## 1. The Rise and Fall of IS-Led Growth

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### A. The Industrial Policy Debate
- Industrial policy regained prominence after the 2008 financial crisis and especially after the COVID-19 pandemic amid concerns about income inequality, hollowing out of the middle class, and deindustrialization.
- Shift from 1980s “Washington Consensus” towards renewed interest in state-led industrial strategies (Cherif, Hasanov and Engher 2023; Cherif and Hasanov 2019a, 2019b).
- Major public industrial policy initiatives cited:
  - China: “Made in China 2025” (2015) targeting ten key sectors including chips, artificial intelligence (AI), robotics, industrial sensors, cloud computing, and batteries.
  - EU: Strategic Plan for Batteries (2018); EU Industrial Strategy (2020); European Chips Act (2021); Net-Zero Industry Act (2023).
  - U.S.: Endless Frontier Act (2021); CHIPS for America Act (2021) leading to the CHIPS and Science Act (2022); Inflation Reduction Act (IRA, 2022).
- Estimated public spending of the IRA over 2023-2031 is "in the order of 400-900 billion dollars" (which could crowd in private investment of potentially similar size).

### B. Two Distinct Industrial Policy Strategies: IS versus EO
- Definitions:
  - Import Substitution (IS) / inward-looking: domestic market protection, developing heavy industries for domestic consumption, sometimes subsidizing intermediate/capital goods via an overvalued exchange rate.
  - Export-Oriented (EO) or “True” Industrial Policy (TIP): state intervention to channel resources toward sophisticated industries, ensure intense competition and accountability for support received, and prioritize export markets.
- Cherif and Hasanov (2019b) characterize TIP by three principles:
  - state intervention to channel resources toward sophisticated industries (e.g., electronics);
  - ensuring intense competition and accountability for support received;
  - export orientation.
- Main argument: differences in outcomes arise primarily from market orientation at the onset—IS (inward-looking) versus EO (export-focused) as in the Asian miracles.

### C. Why Export Orientation Matters — Key Mechanisms
- Export orientation delivers multiple critical advantages:
  - (i) Market signal: continuous market feedback free of protected domestic market distortions.
  - (ii) Fierce competition: foreign-market competition forces productivity gains, innovation, and technological updating.
  - (iii) Spillovers: deeper value chain integration domestically and globally produces positive spillovers and competitive pressures.
  - (iv) Market size: access to larger markets enables economies of scale and economies of scope for a greater variety of products.
  - (v) Accountability: global competition can mitigate cronyism and corruption by making firm survival contingent on competitiveness.

### D. Pitfalls of Import Substitution (IS)
- IS policies often:
  - lack proper market feedback and fail to stimulate sufficient innovation or large productivity gains;
  - create reliance on imported critical inputs or low-quality domestic inputs;
  - allow state support to be captured by well-connected firms in absence of accountability, sustaining inefficient producers;
  - expose fiscal vulnerabilities to external/domestic shocks, triggering crises and loss of accumulated learning and human capital.

### E. Empirical Evidence: Two Main Periods and Comparative Performances
- Two broad periods for developing countries:
  - Golden age of IS over 1965–1980: rapid growth in manufacturing output.
  - Collapse of that manufacturing growth over 1980–2010 as IS policies were rolled back.
- Data sources: GGDC 10-Sector database (Timmer, de Vries, and de Vries 2015) and Penn World Tables 9.0.
- Representative manufacturing value added (VA) per capita annual growth rates over 1965–1980:
  - Indonesia: about 10 percent.
  - Nigeria: 7 percent.
  - Brazil: 6 percent.
- Asian miracles’ manufacturing VA per capita growth over 1965–1980:
  - Korea: 15 percent.
  - Taiwan Province of China: around 12 percent.
  - Singapore: around 12 percent.
- During 1980–2010, average manufacturing growth rates among developing economies dropped significantly; Asian miracles largely sustained relatively high manufacturing growth rates, especially when controlling for initial income per capita.

### F. Measuring Export Orientation and Structural Breaks
- Outcome-based export-orientation proxy: strength of short-term relationship between growth of manufacturing value added and growth of manufacturing exports (significance, elasticity of exports to domestic production, and R-squared).
  - If relationship significant and elasticity close to or greater than one → country considered export-oriented by this measure.
- Structural break test specification: ∆log(manufacturing exports) = c + α ∆log(manufacturing value added) + ε; break year dated where null of no structural break rejected at 5 percent level.
- Kernel distribution of break years shows a mode in the mid- to late-1970s; most countries that changed short-term export/import orientation had done so by 1990.
- Over 1970–1990, the Asian miracles are outliers with high R-squared and significant positive elasticity linking export growth to manufacturing output (example: Korea).

### G. Synthesis and Implications
- Few developing countries pursued large-scale EO in the 1960s and 1970s; the Asian miracles were among the few and sustained manufacturing growth.
- Export orientation could be the “secret” ingredient of successful industrial policy because it provides competitive pressure, market feedback, spillovers, scale, and accountability absent in IS.
- Protectionism and high tariffs were used historically but may not be necessary today; alternative state interventions to develop capabilities exist, and high tariffs may be counterproductive even for large economies.

### Appendix Figure 1) — Kernel distributions and short-term relationships (summary points)
- Figure 2: Kernel Distribution of Structural Break Years (sources: GGDC and WDI): substantial change in growth policy in the mid- to late-1980s (Cherif, Hasanov, and Engher 2023).
- Figure 3: Short-term Relationship Between Manufacturing Exports and Output, 1970–1990.

### Export performance and Manufacturing Export Intensity (MEI)
- Korea trajectory:
  - Most advanced economies exported between 25 and 150 times as much manufacturing per capita as Korea in 1965; by 1980 these ratios shrank to between twice to 8 times Korea’s exports per capita.
  - No sampled developing economy remotely kept pace with Korea in manufacturing exports per capita by 1980.
  - Malaysia and Tunisia: exported more per capita than Korea in 1965 but by 1980 were about 40 percent and 20 percent of Korea’s exports per capita, respectively.
- MEI definition: MEI = (country’s exports of manufacturing ÷ world manufacturing exports) normalized by country share in world population.
  - Example: 2010 — Switzerland population weight ≈ 0.11 percent; manufacturing export market share = 1.7 percent → MEI ≈ 150 percent; this was 250 times greater than India’s MEI (India ≈ 18 percent of world population at the time).
- Median MEI differences:
  - 1970: median MEI in low and middle-income economies = 5 percent; high-income economies = 270 percent.
  - 2014: low and middle-income economies = 8 percent; high-income economies = 370 percent.
- Conclusion: the gap in manufacturing export intensity between poor and rich countries was immense and widened further.

### Manufacturing output growth vs. MEI change, 1970–1990 (patterns)
- Korea (and to a lesser extent Malaysia and Thailand): simultaneous high manufacturing VA per capita growth and large increases in MEI; by 1990 Korea approached initial MEI level of median high-income country.
- China and Indonesia: high manufacturing output growth (7–10 percent on average in per capita terms) without much change in MEI → evidence of persistent import substitution until late 1980s.
- Egypt, Nigeria, India: relatively high manufacturing output growth but negative change in MEI (import substitution pattern).
- Chile: laissez-faire policy led to anemic manufacturing output growth and collapse in MEI.
- Sample source: developing economies as of the 1970s (Timmer, de Vries, and de Vries 2015).

### Case study: India’s import substitution (post-independence to late 1970s)
- Policy regime features:
  - Central licensing system (capacity licenses specifying total capacity and yearly production, number of shifts; separate licenses for imports and for technical support labeled “foreign collaboration”).
  - Domestic producers shielded from international competition; domestic competition heavily curtailed; extensive monopoly rents.
  - Price controls; licensing delays of several years.
- Distortions and consequences:
  - Profits depended on securing licenses more than on productivity or innovation.
  - Technology stagnation (example: automotive industry producing models from the early 1950s by 1970).
  - Vertical integration often prevented; imported inputs sometimes banned leading to prices up to tenfold international prices.
  - Export requirements minimal and often met only at required minimums due to paperwork, capacity expansion costs, delivery difficulties, recurrent disruptions, and lower profit margins in export markets.
- India reformed starting in 1991; liberalization increased competition and growth thereafter, but full export potential not realized by the 2020s.

### Distinction: ISI versus EO — tools, objectives, and accountability
- ISI and EO both used tariffs and subsidies superficially, but key differences:
  - ISI: tariffs and barriers limit domestic competition; little specific incentive to export; outcomes include initial production gains but later stagnation in R&D, dependence on imports, small-scale production, failure to reap economies of scale; political economy capture by protected firms.
  - EO (Asian miracles): export promotion primary objective; tariffs used to provide minimal rents while firms faced fierce competition; tools included production and investment subsidies, cheap financing, technology-transfer financing licenses, public research institutes, government procurement, tax incentives.
  - EO emphasized conditional support and strict accountability (e.g., export quotas in Korea; preferred credit and tariff conditions in Taiwan Province of China).
  - Firms under EO were expected to export, invest in R&D, scale production for economies of scale, integrate vertically or build supplier networks, and adapt to global market signals.
  - Outcome: firms became resilient to tariff removal and benefited from devaluation; EO served as organizing framework.

### Illustrative contrast: Hyundai (KOR) vs. Proton (MYS)
- Hyundai:
  - Aggressive targeting of foreign markets from inception.
  - Mid-1980s factory annual capacity of 300,000 (exceeding domestic annual demand of 250,000) and dedicated to the U.S. market.
  - Built dealerships and advertising networks; leapfrogged technologically and produced its own engines in the 1980s.
- Proton:
  - Inward-oriented, modest production capacity, relied on Mitsubishi engines, insignificant exports, domestic market challenged by foreign automakers despite tariffs/subsidies.

### Vertical Specialization Industrialization (VSI) and GVCs
- EO encompasses VSI: specialization in intermediate goods and niches within GVCs or regional networks (assembly and low value-added tasks as entry points).
- Alternative EO path: final goods marketed in advanced markets (Korea/Japan).
- Principle: domestic market is not the primary target; policies restricting imports of intermediate goods are detrimental. True industrial policy should encourage technological upgrading, capability accumulation, and global competition.

### Limits of pure laissez-faire: Chile example
- Chile’s outcomes:
  - 1970 MEI: Chile ≈ 200 percent vs. developing median 5 percent and Malaysia ≈ 80 percent.
  - 1990 MEI: Chile ≈ 70 percent; Malaysia ≈ 210 percent.
  - Manufacturing per capita growth over 1970–1990: Chile = 0.35 percent annual; Malaysia > 8 percent annual.
- After 1982 Chile raised tariffs and introduced programs (e.g., “reintegro simplificado” over 1985–2003), CORFO and Fundación Chile supported targeted sectors (salmon success linked to state intervention), yet Chile’s productivity growth stagnated since 1970 and GDP per capita relative to the U.S. fluctuated about 20–30 percent until mid-2000s.

### Risk tradeoffs in industrial policy strategies (automotive industry example)
- Three broad strategy choices for a developing economy starting by importing all cars:
  1. Import Substitution Industrialization (ISI)
     - Variants:
       - Quasi-autarky (e.g., India): domestic ownership, minimal MNC links, small trade deficit, high rents to producers, technological divergence, long-term unsustainable.
       - Domestic ownership with foreign partnerships (e.g., Malaysia/Proton): imported critical inputs (engines), automotive trade deficit smaller than full import case, consumer welfare costs.
       - FDI and joint ventures (e.g., Brazil): local production enforced via market access, minimal trade deficit but limited competitiveness and inability to reach frontier in most midsize economies.
     - Risks: failure to achieve economies of scale; production costs between 60 to 150 percent higher than international norm in Latin American auto plants during ISI; lack of innovation; political economy capture; eventual collapse when protections removed.
  2. ISI-EO mix
     - Risks: monopoly rents reduce export pressure; learning takes longer; difficulty monitoring export requirements and quotas; successive trade liberalization makes this approach harder post-1990s.
  3. Pure Export-Oriented (EO)
     - Requires coordination, long-term financing, public goods (skills, infrastructure), and patient private financing to cross the "valley of death".
     - EO leads to higher initial trade/fiscal deficits as inputs are imported, but over time exports can generate surpluses and allow firms to reach technological frontier.

### Global context and viability of EO in the 21st century
- World trade trends:
  - Total trade (exports + imports of goods and services) as share of world GDP: hovered around 55 percent of GDP in recent decades; peaked a little over 60 percent of GDP historically.
  - Manufacturing share of global GDP: 16 percent in 2022 vs. about 20 percent in the late 1990s.
  - Services trade ≈ 10 percent of GDP in the past decade.
- Geopolitical considerations: non-aligned countries may leverage proximity to large blocs; some trade diversion from China to Vietnam and Mexico in the late 2010s.
- Conclusion: despite geopolitical risks, the world remains integrated; EO remains viable and preferable for catch-up countries given GVCs and regional trade opportunities.

### Recent policy revival and the U.S. Inflation Reduction Act (IRA) example
- Broader revival: advanced economies announced packages to support chips, renewables, batteries citing resilience, national security, and climate goals.
- IRA features:
  - Long-term subsidized financing to build green infrastructure; main tools include investment and production tax credits (e.g., $ per kWh production credits) — tax credits represent about a third of estimated fiscal cost (Bistline et al. 2023).
  - Tax credits structured with additional amounts for compliance with combinations of labor, domestic content, or location requirements.
  - Labor requirement incentive dominates local content incentive: labor incentive ≈ 2.5 and 9 times the additional incentive for local content (Bistline et al. 2023).
  - EV purchase tax credit: conditional on final assembly in North America, local content for batteries with restrictions increasing over time, and sourcing of minerals from countries with trade agreements with the U.S.
  - Import/content specifics: import content of inputs capped at about 60 percent for green infrastructure; a 100 percent steel sourcing requirement for local content bonus is explicitly protectionist.
- IRA vs. classical ISI:
  - IRA finances new non-tradable supply (clean power) rather than substituting an existing tradable product; both domestic and foreign firms can compete for tax credits.
  - Risks: local content requirements and protectionist elements could reduce innovation, increase prices, or lead to complacency without explicit export orientation and capability development.
- Historical parallel: KfW in Germany extended 126 billion dollars (in 2012 prices) of subsidized loans to develop renewable technologies; share of renewables in electricity rose from 6 percent in 2000 to more than 40 percent in 2017.

### Policy recommendations and implementation priorities (from IRA discussion)
- To maximize long-term benefits of IRA-type programs:
  - Coordinate with research and innovation initiatives (e.g., the Science Act) to develop industrial capabilities around targeted technologies.
  - Resolve administrative, legal, and regulatory hurdles to expedite projects and implementation.
  - Improve the innovation ecosystem’s instruments and functioning.
  - Enforce antitrust regulation to guarantee high competition, especially in sectors de facto protected by domestic content clauses.
- Cautions:
  - Local content requirements should be accompanied by explicit export orientation and capability-building policies to avoid repeating historical ISI pitfalls.
  - Temporary subsidies should be designed to incentivize innovation and export-readiness rather than create permanent protected rents.

### Local content requirements, capabilities, and design of industrial policy packages
- Few countries that tried LCRs (e.g., China and Spain) managed to create sizable export capacities in wind and solar components, indicating LCRs alone may not suffice.
- China’s breakthrough in large-scale production benefited from existing advanced capabilities in electronics (Pisano and Shih 2012).
- In designing packages (IRA, EU Green Deal), developing capabilities is more important than protectionist measures.
- Effective tools include financing, training, and procurement that allow state monitoring, ensure accountability, and keep firms focused on efficiency and innovation.
- Taiwan Province of China strategy: develop capabilities first, then connect firms to multinational value chains.
- Tradeoffs: LCRs/tariffs may yield short-run benefits (higher local employment, lower initial fiscal outlays, stronger resilience) but entail technological and political-economy risks likely to grow over time.

### H. Conclusion — export orientation versus import substitution (IS)
- Key argument: the primary difference between successes of Asian miracles (TIP) and failures of IS policies in many developing countries in the 1960s–1970s lies in export orientation.
- Asian miracles combined export orientation with protectionist measures; protection often aimed to provide revenues while firms conquered foreign markets and to manage current account balances.
- Export targets were explicitly set by the state in many cases (Wade 1990, Chang 2002).
- IS policies can build manufacturing and capabilities, but without export orientation they:
  - may not accelerate productivity gains and innovation;
  - may fail to create dense networks of competitive suppliers;
  - tend to create an illusion of self-sufficiency while remaining dependent on imports of critical inputs;
  - produce uncompetitive and ultimately unsustainable industries.
- Pure laissez-faire is not necessarily superior.
- Following TIP principles—export orientation, capability development, accountability, and competitive pressure—can potentially yield high sustained growth as illustrated by Asian miracles.
- Race for microchips and renewable technologies: protectionist temptation exists, but a “race to the top” focused on capability development, competition, and technology diffusion is preferred. Chips are emphasized as key components in the energy transition.
- International evidence: industrial policy is not zero-sum; historical growth of industrializers did not make others poorer; large volumes of international trade and intra-industry trade suggest scope for global cooperation and broad participation in technology value chains.

*IMF Working Paper chapter: "1. The Rise and Fall of IS-Led Growth" from wpiea2024086-print-pdf*

### 1. The Rise and Fall of IS-Led Growth ..................................................................................

### 1. The Rise and Fall of IS-Led Growth

### A. The Industrial Policy Debate
- Since the financial crisis of 2008 and especially after the COVID-19 pandemic, the industrial policy narrative has gained renewed prominence amid concerns about income inequality, hollowing out of the middle class, and deindustrialization.
- From the 1980s “Washington Consensus” emphasis on free market reforms, liberalization, and privatization, industrial policy had been considered a fringe idea but has reentered public debate (Cherif, Hasanov and Engher 2023; Cherif and Hasanov 2019a, 2019b).
- Major public industrial policy initiatives cited:
  - China: “Made in China 2025” (2015) targeting ten key sectors including chips, artificial intelligence (AI), robotics, industrial sensors, cloud computing, and batteries.
  - EU: Strategic Plan for Batteries (2018); EU Industrial Strategy (2020); European Chips Act (2021); Net-Zero Industry Act (2023).
  - U.S.: Endless Frontier Act (2021); CHIPS for America Act (2021) leading to the CHIPS and Science Act (2022); Inflation Reduction Act (IRA, 2022).
- Estimated public spending of the IRA over 2023-2031 is "in the order of 400-900 billion dollars" (which could crowd in private investment of potentially similar size).

### B. Two Distinct Industrial Policy Strategies: IS versus EO
- The paper distinguishes two fundamental principles of industrial policy based on market focus:
  - Import Substitution (IS) / inward-looking policies: focus on domestic market protection, often developing heavy industries for domestic consumption, sometimes subsidizing intermediate/capital goods via an overvalued exchange rate.
  - Export-Oriented (EO) or “True” Industrial Policy (TIP): state intervention to channel resources toward sophisticated industries, ensure intense competition and accountability for support received, and prioritize export markets.
- Cherif and Hasanov (2019b) characterize TIP by three key principles:
  - state intervention to channel resources toward sophisticated industries (e.g., electronics);
  - ensuring intense competition and accountability for support received;
  - export orientation.
- Differences in outcomes are argued to arise mainly from market orientation at the onset: inward-looking IS versus export orientation in the Asian miracles.

### C. Why Export Orientation Matters — Key Mechanisms
- Export orientation delivers multiple critical advantages:
  - (i) Market signal: continuous market feedback free of protected domestic market distortions.
  - (ii) Fierce competition: foreign-market competition forces productivity gains, innovation, and technological updating.
  - (iii) Spillovers: deeper value chain integration domestically and globally produces positive spillovers and competitive pressures.
  - (iv) Market size: access to larger markets enables economies of scale and economies of scope for a greater variety of products.
  - (v) Accountability: global competition can mitigate cronyism and corruption by making firm survival contingent on competitiveness.

### D. Pitfalls of Import Substitution (IS)
- IS policies, by focusing on domestic markets, lack proper market feedback, may not stimulate sufficient innovation or large productivity gains, and often create reliance on imported critical inputs or low-quality domestic inputs.
- In absence of accountability, state support under IS can be captured by well-connected firms, sustaining inefficient producers who rely on protection.
- External or domestic shocks (e.g., collapse in commodity prices) can trigger crises that expose fiscal vulnerabilities, force withdrawal of state support, and lead to widespread bankruptcies with loss of accumulated learning and human capital.

### E. Empirical Evidence: Two Main Periods and Comparative Performances
- The authors document two broad periods for developing countries:
  - A golden age of IS over 1965–1980 characterized by rapid growth in manufacturing output.
  - A collapse of that manufacturing growth over 1980–2010 as IS policies were rolled back.
- Empirical source: GGDC 10-Sector database (Timmer, de Vries, and de Vries 2015) and Penn World Tables 9.0.
- Representative manufacturing value added (VA) per capita annual growth rates over 1965–1980 for selected developing economies:
  - Indonesia: about 10 percent.
  - Nigeria: 7 percent.
  - Brazil: 6 percent.
- Asian miracles’ manufacturing VA per capita growth over 1965–1980:
  - Korea: 15 percent.
  - Taiwan Province of China: around 12 percent.
  - Singapore: around 12 percent.
- During 1980–2010, average manufacturing growth rates among developing economies dropped significantly; manufacturing stagnated in many economies, while the Asian miracles largely sustained relatively high manufacturing growth rates, especially controlling for initial income per capita.

### F. Measuring Export Orientation and Structural Breaks
- Export orientation is proxied by the strength of the short-term relationship between growth of manufacturing value added and growth of manufacturing exports: the correlation significance, the elasticity of exports to domestic production, and R-squared.
  - If the relationship is significant and elasticity is close to or greater than one, the country is considered export-oriented by this outcome-based measure.
- A structural break test is used to detect changes in the relationship between production and exports and to date the break year (regression model: ∆log(manufacturing exports) = c + α ∆log(manufacturing value added) + ε).
- The kernel distribution of break years (where the null of no structural break is rejected at a 5 percent level) shows a mode in the mid- to late-1970s; most countries that changed short-term export/import orientation had done so by 1990.
- Over 1970–1990, the Asian miracles are clear outliers with high R-squared and significant positive elasticity linking export growth to manufacturing output (example: Korea).

### G. Synthesis and Implications
- Very few developing countries pursued large-scale export-oriented industrialization in the 1960s and 1970s; the Asian miracles were among the few who did and subsequently sustained manufacturing growth.
- The analysis suggests that export orientation could be the “secret” ingredient of successful industrial policy because it provides continuous competitive pressure, market feedback, spillovers, scale, and accountability that inward-looking IS policies lack.
- The paper argues that protectionism and high tariffs were used historically but may not be necessary today; alternative state interventions to develop new capabilities and industries exist, and high tariffs may be counterproductive even for large economies.

*IMF Working Paper chapter: "1. The Rise and Fall of IS-Led Growth" from wpiea2024086-print-pdf*

### Appendix Figure 1).

### wpiea2024086-print-pdf - Appendix Figure 1)

### Kernel distributions and short-term relationships (figures)
- Figure 2: Kernel Distribution of Structural Break Years (sources: GGDC and WDI). Noted textual point: There was a substantial change in growth policy in the mid- to late-1980s (Cherif, Hasanov, and Engher 2023).
- Figure 3: Short-term Relationship Between Manufacturing Exports and Output, 1970–1990 (sources: GGDC and WDI).

### Export performance: Korea vs. the world
- Most advanced economies exported between 25 and 150 times as much manufacturing per capita as Korea in 1965; by 1980 these ratios shrank to between twice to 8 times Korea’s exports per capita.
- Korea stands out: no sampled developing economy even remotely kept pace with Korea in manufacturing exports per capita by 1980.
- Examples: Malaysia and Tunisia exported more manufactured goods per capita than Korea in 1965 but represented about 40 percent and 20 percent of Korea’s exports by 1980, respectively.

### Manufacturing Export Intensity (MEI): definition and cross-country gaps
- MEI = (country’s exports of manufacturing ÷ world manufacturing exports) normalized by country share in world population.
- Example: In 2010, Switzerland population weight ≈ 0.11 percent; manufacturing export market share = 1.7 percent → MEI ≈ 150 percent; this was 250 times greater than India’s MEI (India ≈ 18 percent of world population at the time).
- Median MEI differences:
  - 1970: median MEI in low and middle-income economies = 5 percent; high-income economies = 270 percent.
  - 2014: low and middle-income economies = 8 percent; high-income economies = 370 percent.
- Conclusion: The gap in manufacturing export intensity between poor and rich countries was immense and widened further.

### Manufacturing output growth vs. MEI change, 1970–1990 (Figure 5)
- Sample: developing economies as of the 1970s (data from Timmer, de Vries, and de Vries 2015).
- Patterns:
  - Korea (and to a lesser extent Malaysia and Thailand): simultaneous high growth in manufacturing value added per capita and large increases in MEI. By 1990, Korea approached the initial MEI level of the median high-income country.
  - China and Indonesia: achieved high manufacturing output growth (7–10 percent on average in per capita terms) without much change in MEI → evidence of import substitution policies persisting until the late 1980s.
  - Egypt, Nigeria, India: relatively high manufacturing output growth but negative change in MEI (import substitution pattern).
  - Chile: laissez-faire policy led to anemic manufacturing output growth and collapse in MEI (clear outlier).

### Case study: India’s import substitution (state micromanagement)
- Period: post-independence (1947) until late 1970s; India embarked on ambitious IS policy achieving high domestic production by 1970.
- Key features of the policy regime:
  - Central licensing system (capacity licenses specifying total capacity and yearly production, number of shifts; separate licenses for imports, for technical support labeled “foreign collaboration”).
  - Domestic producers shielded from international competition; domestic competition heavily curtailed; extensive monopoly rents.
  - Price controls; licensing delays of several years.
- Consequences and distortions:
  - Profits depended on securing licenses more than on productivity or innovation.
  - Technology stagnation (e.g., automotive industry producing models from the early 1950s by 1970).
  - Vertical integration often prevented; imported inputs sometimes banned leading to prices up to tenfold international prices.
  - Export requirements often minimal and met only at required minimums due to paperwork, capacity expansion costs, delivery difficulties, recurrent disruptions, and lower profit margins in export markets.
- Historical note in source: India reformed starting in 1991; liberalization increased competition and growth in subsequent decades, but full export potential not realized by the 2020s.

### Distinction: Import Substitution Industrialization (ISI) vs. Export Orientation (EO)
- Superficial similarity: both ISI and EO used tariffs and subsidies; however, key differences lie in objectives and accountability.
- Typical ISI in developing economies:
  - Tariffs and barriers limit domestic competition; no specific incentive to export.
  - Outcomes: initial increases in production and capabilities but over time little R&D, weak innovation, dependence on imported intermediate goods, small-scale production, failure to reap economies of scale.
  - Political economy: protected firms earn rents, reduce incentives to innovate, lobby to maintain protection — unsustainable long run.
- Asian miracles (EO framework):
  - Export promotion was the primary objective; tariffs were a tool to provide minimal rents while firms faced fierce competition at home and abroad.
  - Wide array of tools: production and investment subsidies, cheap financing, financing licenses for technology transfers, public research institutes, government procurement, tax incentives.
  - Conditional support and strict accountability (e.g., export quotas in Korea; preferred credit and tariff conditions in Taiwan Province of China).
  - Firms were expected to export, invest in R&D, set large production capacities to exploit economies of scale, integrate vertically or develop supplier networks, and adapt to global market signals.
  - Outcome: firms became resilient to tariff removal and benefited from devaluation; EO served as the organizing framework for state policies and support.

### Illustrative contrast: Hyundai (KOR) vs. Proton (MYS)
- Hyundai: aggressive targeting of foreign markets from inception; a mid-1980s factory with annual capacity of 300,000 (exceeding domestic annual demand of 250,000) and dedicated to the U.S. market; built networks of dealerships and advertising; leapfrogged technologically and produced its own engines in the 1980s.
- Proton: inward-oriented, modest production capacity, relied on Mitsubishi engines, insignificant exports, domestic market challenged by foreign automakers despite tariffs/subsidies.

### Vertical Specialization Industrialization (VSI) and Global Value Chains (GVCs)
- EO includes VSI: specialization in intermediate goods and niches in GVCs or regional networks (assembly and low value-added tasks possible entry points).
- Alternative EO path: final goods marketed in advanced markets (Korea/Japan model).
- Principle: in both VSI and traditional EO, domestic market is not the primary target; policies restricting imports of intermediate goods would be detrimental. True industrial policy requires state intervention to encourage technological upgrading, capability accumulation, and global competition.

### Limits of pure laissez-faire (Chile example)
- Chile pursued laissez-faire until early 1980s with poor manufacturing outcomes:
  - 1970 MEI: Chile ≈ 200 percent vs. developing median 5 percent and Malaysia ≈ 80 percent.
  - 1990 MEI: Chile ≈ 70 percent; Malaysia ≈ 210 percent.
  - Manufacturing per capita growth over 1970–1990: Chile = 0.35 percent annual; Malaysia = more than 8 percent annual.
- Post-1982: Chile raised tariffs, introduced programs (e.g., “reintegro simplificado” over 1985–2003), CORFO and Fundación Chile supported targeted sectors (salmon success linked to state intervention), yet Chile’s productivity growth stagnated since 1970 and GDP per capita relative to the U.S. fluctuated about 20–30 percent until mid-2000s.

### Risk tradeoffs in industrial policy strategies (automotive industry example)
- Three broad strategy choices for a developing economy (DEC) starting by importing all cars:
  1. Import Substitution Industrialization (ISI)
     - Variants:
       - Quasi-autarky (e.g., India): domestic ownership, minimal MNC links, small trade deficit, high rents to producers, technological divergence from frontier, long-term unsustainable.
       - Domestic ownership with foreign partnerships (e.g., Malaysia/Proton): imported critical inputs (engines), automotive trade deficit smaller than full import case, consumer welfare costs.
       - FDI and joint ventures (e.g., Brazil): local production enforced via market access, minimal trade deficit but limited competitiveness and inability to reach frontier in most midsize economies.
     - Risks: failure to achieve economies of scale, higher production costs (studies show production costs between 60 to 150 percent higher than international norm in Latin American auto plants during ISI), lack of innovation, political economy capture, and eventual collapse when protections removed.
  2. ISI-EO mix
     - Risks: monopoly rents reduce export pressure; learning takes longer; difficulty in monitoring export requirements and quotas; successive trade liberalization makes this approach harder post-1990s.
  3. Pure Export-Oriented (EO)
     - Requires coordination, long-term financing, support in public goods (skills, infrastructure), patient private financing to cross "valley of death".
     - EO leads to higher initial trade/fiscal deficits as inputs are imported, but over time exports can generate surpluses and allow firms to reach the technological frontier (Figure 6 label “KOR”).
- Overall argument: EO component is key to long-run success; tariffs and local content requirements are means but not sufficient and often counterproductive.

### Global context and the viability of export orientation in the 21st century
- World trade trends:
  - Total trade (exports + imports of goods and services) as share of world GDP: hovered around 55 percent of GDP in recent decades; peaked a little over 60 percent of GDP historically.
  - Manufacturing share of global GDP: 16 percent in 2022 vs. about 20 percent in the late 1990s.
  - Services trade ≈ 10 percent of GDP in the past decade.
- Geopolitical considerations (“Cold War II”): non-aligned countries may leverage proximity to large blocs; some trade diversion from China to Vietnam and Mexico noted in late 2010s.
- Conclusion: despite geopolitical risks, the world remains integrated; EO remains viable and likely preferable; GVCs and regional trade areas create new opportunities, especially for catch-up countries.

### Recent policy revival and the example of the U.S. Inflation Reduction Act (IRA)
- Broader revival: advanced economies announced packages to support chips, renewables, batteries citing resilience, national security, and climate goals.
- IRA characteristics:
  - Long-term subsidized financing program to build green infrastructure; main tools include investment and production tax credits (e.g., $ per kWh production credits) — tax credits represent about a third of estimated fiscal cost (Bistline et al. 2023).
  - Tax credits structured with additional amounts for compliance with combinations of labor, domestic content, or location requirements.
  - Labor requirement incentive dominates local content incentive: labor incentive ≈ 2.5 and 9 times the additional incentive for local content (Bistline et al. 2023).
  - EV purchase tax credit: conditional on final assembly in North America, local content for batteries with restrictions increasing over time, and sourcing of minerals from countries with trade agreements with the U.S.
  - Import/content specifics: import content of inputs capped at about 60 percent for green infrastructure; a 100 percent steel sourcing requirement for local content bonus is explicitly protectionist.
- IRA vs. classical ISI:
  - IRA’s main component finances new non-tradable supply (clean power) rather than substituting an existing tradable product; both domestic and foreign firms can compete for tax credits.
  - Risks: local content requirements and protectionist elements could reduce innovation, increase prices, or lead to complacency without explicit export orientation and capability development.
- Historical parallel: KfW in Germany extended 126 billion dollars (in 2012 prices) of subsidized loans to develop renewable technologies; share of renewables in electricity went from 6 percent in 2000 to more than 40 percent in 2017 — an example of successful public financing for green infrastructure.

### Policy recommendations and implementation priorities (from the IRA discussion)
- For IRA-type programs to maximize long-term benefits, critical actions include:
  - Coordinate with research and innovation initiatives (e.g., the Science Act) to ensure development of industrial capabilities around targeted technologies.
  - Resolve administrative, legal, and regulatory hurdles to expedite projects and implementation.
  - Improve the innovation ecosystem’s instruments and functioning.
  - Enforce antitrust regulation to guarantee high competition, especially in sectors de facto protected by domestic content clauses.
- Cautions:
  - Local content requirements should be accompanied by explicit export orientation and capability-building policies to avoid repeating historical ISI pitfalls (e.g., Brazil, India).
  - Temporary subsidies should be designed to incentivize innovation and export-readiness rather than create permanent protected rents.

*Italic: Content derived from wpiea2024086-print-pdf - Appendix Figure 1) (source: IMF working paper text provided).*

### introduction (e.g., Hansen et al. 2020 and Scheifele et al. 2022). China, for example, managed its breakthrough

### introduction

### Local content requirements, capabilities, and outcomes
- Very few countries that tried LCRs, such as China and Spain, managed to create sizable export capacities in wind and solar energy components, indicating that LCRs may not be sufficient to help industries become cost competitive and that first developing capabilities is key.
- China managed its breakthrough in large-scale production because it already possessed advanced capabilities in electronics, which is closely related to the production of solar PVs (Pisano and Shih 2012).

### Design of industrial policy packages (IRA, EU Green Deal) and alternative tools
- In the design of industrial policy packages like the IRA and the EU Green Deal, policies to develop local capabilities are much more important than protectionist measures.
- Developing capabilities and helping firms grow, export, and build innovative industries can be achieved through tools such as:
  - financing,
  - training,
  - procurement that allow the state to monitor progress, ensuring accountability, and keep firms focused on improving efficiency and producing innovation.
- The strategy of Taiwan Province of China to first develop capabilities before plugging firms into the value chains of multinationals was successful.
- The technological and political economy risks of imposing local content requirements or tariffs need to be assessed against the potential short-run benefits of:
  - higher local employment,
  - lower initial fiscal outlays,
  - stronger resilience.
- These risks, along with macroeconomic risks, are most likely going to increase over time, negating the short-run benefits.
- An alternative strategy to protectionism that develops capabilities and pushes firms to compete both domestically and internationally would increase the chances of success.
- Footnote/example of coordination: One example of a possible coordination would be for the NSF, which manages the fund, to put more weight on sectors (renewables, EVs, etc.) and locations that are relevant for the IRA incentives.

### H. Conclusion — export orientation versus import substitution (IS)
- Key argument: A key difference between the success of the industrial policies of the Asian miracles, or “true” industrial policies, TIP in our formulation, and the failure of the IS policies in many developing countries in the 1960s and 1970s lies in the lack of export orientation of IS-pursuing countries.
- The Asian miracles combined export orientation with protectionist measures; protection often aimed to ensure a stable source of revenues for firms while they were conquering foreign markets and to manage current account balances in the absence of sizable natural resource endowments.
- Export targets were explicitly set by the state in many cases (Wade 1990, Chang 2002).
- Example contrast: Korea’s Hyundai succeeded while Malaysia’s Proton failed (Cherif and Hasanov 2019c).

### Dynamics and risks of IS policies
- IS policies can achieve growth in manufacturing and accumulation of new capabilities over time.
- However, without export orientation:
  - IS policies may not speed up productivity gains and innovation,
  - may fail to create a dense network of domestic competitive and productive suppliers,
  - tend to create an illusion of self-sufficiency while industries remain dependent on imports of critical inputs and capital goods or on domestic inputs with subpar quality,
  - can produce uncompetitive, unproductive, and ultimately “unsustainable” industries that cannot thrive without state support even after decades.
- The cascade of failures in the 1980s and 1990s led to a widespread blanket condemnation of all types of industrial policies as inefficient, wasteful, and conducive to corruption.
- At the other extreme, pure laissez-faire policies would not necessarily achieve better results.
- Following the principles of a “true” industrial policy, TIP, would potentially result in high sustained growth as illustrated by the Asian miracles.

### Race for microchips and renewable technologies; preferred approach
- The race for microchips and renewable technologies such as batteries in the 2010s and 2020s is bringing back the protectionist temptation, but the alternative path is preferred.
- For success, a race to the top is possible, bringing technology costs down and benefiting all countries.
- The energy transition requires substantial investment and innovation; the economic pie is not fixed and must grow.
- Emphasis should be on using the full spectrum of “soft” industrial policy tools, including institutions exhibiting “embedded autonomy” (Evans 1995), and relying on market signals such as exports to enforce accountability and competition.
- All countries can and should attempt to export without stifling international competition; many should enter the race for chips and renewable technologies or their value chains.
- Both domestic and international competition is key to provide opportunities for all firms while international cooperation on the rules of the game would benefit all countries.
- Developing countries could benefit substantially from technology transfers, especially to support green transition.
- Note: “Chips will be a key component in the energy transition as they enter in the production of EVs and renewables, among others.” (footnote 42)

### International perspective: industrial policy is not zero-sum
- Historical evidence: European countries did not become poorer because the U.S. developed its industry in the 19th century; Western countries did not become poorer because Japan and Korea developed in the 20th century.
- Most global trade takes place among industrialized nations and is largely intra-industry; this suggests scope for large volumes of international trade in microchips and batteries due to increasing differentiation and more complex value chains.

*IMF Working Paper — The Pitfalls of Protectionism: Import Substitution vs. Export-Oriented Industrial Policy (introduction section)*

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_Source: https://www.imf.org/-/media/files/publications/wp/2024/english/wpiea2024086-print-pdf.pdf_