The Return of Industrial Policy

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Bibliographic details

• Authors: DOUGLAS IRWIN
• Published: June 1, 2023

Geopolitical shift and the trade policy landscape

• Geopolitics is rapidly changing the landscape of world trade; the policy environment of the 1990s and 2000s is described as "a distant memory."
• During that reform period, developing and transition economies opened markets, embraced globalization, and saw the creation of the World Trade Organization with a rules-based system of nondiscriminatory trade.
• Trade interventions are on the rise in the form of:
  • industrial policies and subsidies,
  • import restrictions based on national security and environmental concerns,
  • export controls to punish geopolitical rivals and ensure domestic supply.

Historical context and "misreading history"

• The belief that richer countries succeeded because they protected manufacturing is called "a misreading of history."
• United States historical experience:
  • Despite high tariffs, the United States developed as an open economy—open to immigration, capital, and technology—and one with an exceptionally large domestic market that was fiercely competitive.
  • The United States overtook Britain in per capita income in the late 19th century by increasing labor productivity in the service sector, not by raising productivity in the manufacturing sector (Broadberry 1998).
• Western Europe growth linkage:
  • Growth related to shifting of resources out of agriculture and into industry and services.
  • Trade policies protecting agriculture from low prices likely slowed this transition in countries such as Germany.
• East Asia and South Korea:
  • In 1960, South Korea had exports of just 1 percent of GDP and was dependent on US aid.
  • After devaluing its currency in the early and mid-1960s, Korea’s exports reached 20 percent of GDP by the early 1970s.
  • Main policy credited: setting a realistic exchange rate and cheaper credit for all exporters, not targeted industries (Irwin 2021).
  • Industrial policy (Heavy and Chemical Industry Drive) ran during 1973–79 and was later terminated because of excessive costs and inefficiency; Korea’s rapid growth had already been unleashed before that era.
• Quantitative assessments:
  • Models suggest gains from even optimally designed industrial policies are small and unlikely to be transformative (Bartelme and others 2021).

The new Washington-Beijing-Brussels consensus

• China:
  • Moved away from outward-oriented policies as President Xi Jinping reasserted state control.
  • "Made in China 2025" involved large subsidies to targeted industries; later replaced by "dual circulation" focused on reducing external dependence and self-sufficiency in key technologies.
• United States:
  • Began protecting steel and aluminum industries on national security grounds during the Trump administration.
  • Introduced the 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:
  • Announced in 2020 an industrial strategy to enhance its "open strategic autonomy" in the transition to a green and digital economy.

Risks and empirical examples for developing economies

• General risk assessment:
  • Building national industries through subsidies and trade restrictions is characterized as a risky strategy for developing economies.
  • Subsidies could be expensive with elusive benefits; trade restrictions could trigger protectionism, reduce export earnings, and shrink imports critical for development.
  • Large-scale industrial subsidies seen as a luxury that rich countries can indulge; fiscally strapped developing economies face precarious fiscal balances and uncertain payoffs.
  • Quote 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."
• China shipbuilding example:
  • In 2006, China identified shipbuilding as a "strategic industry" and began massive production and investment subsidies, mainly through cheap loans.
  • Evidence suggests these policies were wasteful (excess capacity), distorted markets, increased industry fragmentation, and benefited state-owned enterprises over more efficient private producers (Barwick, Panle Jia, Myrto Kalouptsidi, and Nahim Bin Zahur. 2019).
  • The shipbuilding industry did not generate significant spillovers to the rest of the economy and showed no evidence of industry-wide learning by doing.
• Sacrificing trade gains:
  • Many countries made progress by engaging with the global economy rather than closing markets.
  • China’s growth attributed primarily to improving productivity in agriculture, allowing foreign investment in manufacturing, and unleashing the private sector—not to industrial policy.
  • India’s 1991 reforms (dismantling the "License Raj") and Bangladesh’s opening to foreign investment are cited as examples of gains from openness.
  • Other countries from Ethiopia to Vietnam benefited more from engagement than isolation.
  • Openness during the reform period saw convergence between rich and poor countries starting around 1990 (Patel, Sandefur, and Subramanian 2021).

Policy implications and recommendations for developing economies

• Avoid a wholesale imitation of US, China, and EU industrial subsidy strategies:
  • Large subsidies and protectionist measures are risky and potentially fiscally unsustainable for developing economies.
• Prioritize public spending where payoffs are more certain:
  • Improve health and education and help poor people rather than directing scarce public funds to domestic industries with uncertain returns.
• Maintain openness to the global economy:
  • Continue to support exports and acquire technology from beyond borders.
  • Remain cautious about trade restrictions that could reduce export earnings and critical imports.
• Be selective and context-specific:
  • Refrain from "copying other countries’ solutions to problems you do not have," per the Hausmann warning.
  • Recognize that optimal policy mixes depend on country-specific circumstances, fiscal capacity, and the potential for productive spillovers.

Source: The Return of Industrial Policy, Douglas Irwin, F&D Magazine, June 2023.

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