Letter IEDI n. 891–Successful sector-specific industrial policies: the cases of China and South Korea
Several countries (developed and developing) have already adopted or still adopt industrial policies to support specific sectors. Is there any economic logic in this type of intervention? This is the question that Ernest Liu, a researcher at Princeton University in the United States, seeks to answer in his article "Industrial policies in production networks", focusing on the development of the branches of heavy industry. This Letter IEDI summarizes his main arguments and conclusions.
Although the prevailing view in the conventional economic literature is that industrial policies tend to always misallocate resources and hamper economic development, Ernest Liu shows evidence from the South Korean and Chinese experiences of an economic rationality that justifies sector-specific aspects of industrial strategies.
Through a detailed theoretical framework based on production networks and the empirical analysis of the cases of China in the recent period and of South Korea in the 1970s, the author concludes that industrial policies directed at upstream sectors in the production chain generated positive aggregate effects in such economies. This is because there is an accumulation of market imperfections in these sectors, resulting from the backward demand spillovers coming from the rest of the economy.
Thus, sectors at the beginning of the productive chain —usually linked to the heavy industry and, therefore, suppliers of industrial inputs to several other productive sectors— accumulate economic distortions that can be positively compensated for, in aggregate terms, through policies that promote the development of those sectors. The success of the experiences of South Korea —with the formulation of an industrial policy that fueled the heavy and chemical industries in the 1970s— and more recently China —through a variety of policy instruments including broad participation of state enterprises in strategic core sectors— reinforces the argument.
The conclusions of the study do not, however, point out the best industrial policies, nor does the author say that they should be adopted indefinitely for specific sectors. The main result of the research refers to the positive economic potential that can be generated by incentives granted, as a priority, to sectors with greater "distortion centrality" —a criterion that weighs the aggregate effect of the marginal expansion of resources to a given sector and the proportional cost to the promotion of such sector.
As shown in the case studies of South Korea and China, such sectors largely correspond to upstream ones— those that are large suppliers of inputs to the various links in the supply chain, but that demand little from others. Thus, stimuli to these industries can have positive effects on the economy as a whole, since they are considered key sectors in the production chain.