Chapter 7: Industrial Policy
Industrialization defined as :
The process of economic development in which a growing part of the
national resources is mobilized to develop technically up- to- date
diversified domestic economic structure characterized by dynamic
manufacturing sector having and producing means of production and
consumer goods and capable of assuring a high rate of growth for the
economy as a whole and of achieving economic and social
progress(UNIDP) .
•This definition states that industrializing is a sustained process.
•It requires the application of modern science and technology to the
production process.
•In the process of industrialization manufacturing sector plays the
leading and dynamic role.
•It also brings about structural transformation of the entire economy
in terms of the composition of output and pattern of employment. 1
Industrial policy(Definitions)
•Industry policy usually relates to those policies whose main direct
effect is upon individual firms and industries, or on industry as a
whole
•The border definition by European commission(1992)
Industrial policy concerns it self the effective and coherent
implementation of all those policies which impinge on the structural
adjustment of industry with a view of promoting competitiveness.
•The narrow definition by Lindback(1981) states that industrial
policy is meant politically actions designed to affect either the
general mechanism of production and resource allocation or the
actual allocations of resources among sectors of production by
means other than general monetary and physical policies which are
designed to influence various macro economic aggregate
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Why industry policy?
• Most government action has some effect on the industrial
sector of the economy. In many instances, this is simply a
consequence of policy elsewhere for example, import
controls to help the balance of payments, prices and
incomes policies to counter inflation and increases in
interest rates to control the money supply or to halt an
exchange rate depreciation.
• In other instances, government action has a more
deliberate effect on the operation of industry, but would
generally still not be considered as 'industry policy'. This
is because the main objective is to influence some other
aspect of the economy, as is often the case with
expenditure on infrastructure and on education.
3
Government intervention
•It is argued that government intervention can improve welfare in
cases where markets fail to provide an efficient utilization of
resources.
•Economists normally argue that intervention in industry is justified
if it results in a net increase in economic welfare.
•The following circumstances are cited where markets produce
levels of output that are not optimal from the society point of view :
1. Monopoly;
2. Public goods, such as public high way , defense;
3. Externalities( +ve & -ve), such as Beekeepers and horticulture
industry ,pollution or congestion;
4. Common property rights;
5. Differences between private and social time preference rates.
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Government intervention
• An analysis of the exact circumstances in which
markets fail is a prerequisite to the examination of
corrective policy measures.
• It is crucial to recognize that the case for industry
policy depends on uncertainty, imperfect
information and as a result the presence of
transaction costs.
5
Approaches to industrial policy
Four distinct approaches to industry policy can be
identified:
1. Laissez-faire
2. Supportive
3. Active
4. Planning
6
Approaches to industrial policy(cont’d)
[Link] laissez-faire approach
•is founded on the presumption that information flows are
perfect, and holds that the market is a better judge of
desirable actions than government agencies.
•Most types of intervention commonly pursued under the
name of industry policy are rejected.
•Appropriate policies are those aimed at strengthening and
promoting a competitive environment (for instance,
through the control of monopoly or measures to remove
ambiguities in the assignment of property rights).
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Approaches to industrial policy(cont’d)
[Link] supportive approach
•also believes in the underlying superiority of market forces, (like
Laissez-faire) but acknowledges the presence of imperfect
information and transaction costs(unlike Laissez-faire).
•Proponents of the supportive approach would agree with the
laissez-faire approach in advocating policies to help markets
function more effectively, but would often disagree over the form of
desirable measures.
•In particular, the supportive approach would argue for intervention
to improve the allocation and enforcement of property rights, to
encourage education and entrepreneurship in order to foster the
process of economic change.
8
Approaches to industrial policy(cont’d)
3. The active approach
•support for wider and more direct government involvement in
the industrial sector.
•This approach differs crucially from the previous ones in that
market judgments are often supplanted by decision or judgments
of government agencies.
•Selected industries would typically be given financial support to
promote restructuring and be protected from external competition
by tariff and non-tariff barriers.
•Although protected from external competition, measures would
again be taken to promote competitiveness domestically.
e.g in Ethiopia leather and textile industry
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Approaches to industrial policy(cont’d)
4. The planning approach
•is a more extreme version of the active approach.
•Its rationale is that welfare can be improved through centralized
planning. It argues that central planners are in a better position -
because of their superior, economy-wide information - to make
welfare-enhancing decisions than individual firms. This advantage is
greater where information flows are imperfect and where the
economy is changing rapidly.
•Intervention is much wider-ranging and more comprehensive than
under the active approach.
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Approaches to industrial policy
The above four approaches can be classified in to two approaches
[Link] (include active and planning)
[Link] ( include the laissez-faire and supportive)
N.B: Whichever approach is adopted ,industrial policy will relate
to four main areas:
• Competition policy
• Regional policy
• Innovation policy
• Trade policy
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Forms of industrial policy
Government intervention takes different forms:
[Link] industrial policy
[Link] industrial policy
[Link] industrial policy
[Link] industry policy
•The objective of accelerative industry policy is to speed up the
innovation process by providing financial support to the most
promising firms, markets or technologies. The premise behind such
a policy is that an economy benefits from adopting innovations
ahead of its trading rivals.
•Tries to improve the dynamism of the economy. Supports by
government could be improve by support of R&D program,
provision of low cost debt(loan) 12
Forms of industrial policy…
2. Deccelerative industry policy
• Deccelerative policies can be of two types.
- It aimed at rescuing ( saving) large firms by providing financial
assistant to solve temporary financial problems, liquidation
bankruptcy. By doing so deccelerative industry policy enables
the exploitation (utilization ) of their capacity
- The second type ,In the case of a firm facing permanent
problems, the intention of deccelerative industry policy is to
moderate the externality effects of its closure and to attain a
better utilization of resources.
- Proponents argue that, while economic forces may quickly lead
to a firm's collapse, markets operate too slowly in re-absorbing
displaced resources. Instead of suggesting intervention designed
to enhance market forces they seek to maintain the employment
of resources in their current use. 13
Forms of industrial policy…
3. Neutral industry policy
•Neutral policy seeks to improve the market framework within which
economic agents operate and such policies do not involve the direct
intervention by the government in to the industry rather market
enhancing/correcting policy.
•According to Lindbeck (1981) the role of the state in neutral
industrial policy is to try to create an economic social and political
environment that is conducive to efficiency and new initiatives
•Compared to accelerative industry policy and decelerative industry
policy ,the neutral industry policy is likely to give rise to
improvement in welfare relatively
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Key Issues And Debate On Industrialization
• With the collapse of primary commodity exports
during the great depression and the acceptance
of Keynesian ideas in developed economies,
laissez faire policies based on orthodox
economic theories, gave way for structuralism
which accorded central role to government in
economic development
• Though the role of the state differed from
country to country there was agreement on
• first, market forces alone fails to bring about
economic dev’t and state must actively seek to
promote it 15
• second, development must be achieved by
transforming predominantly agricultural
economies into industrial ones
• However, developing countries remained
dependent on international capital for
investment, failed to bring about technological
dynamism and to transform the traditional
sector
• B/se of this, neo-liberalism emerged as the
dominant development thinking with strong
support from developed economies, IMF and
WB. 16
• At the heart of neo-liberal policy making is
market liberalization and the reduced role of the
state
• Many developing countries adopted the
prevailing neo-liberal policy package via
stabilization and SAP during 80s and 90s
• The neo-liberal approach however, produced
little result in reducing poverty and debates on
industrialization model continued
17
The Neo-Liberal approach
• Based on comparative cost advantage, the neo-
liberal approach advocates industrialization to be
determined by market forces
• Central to neo-liberal thinking is the notion of
price distortion b/se of gov’t intervention
• the emphasis of the neo-liberal approach is on
individual economic agents and on the free play
of market forces to provide short-term allocative
efficiency
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Neo-liberal policy prescription
• The policy prescription drawn from the neo-
liberal approach are :
• market liberalization i.e. removing price controls,
financial liberalization and less intervention in
labor market
• Trade liberalization i.e., removing import quotas,
reducing tariffs and maintaining a realistic
exchange rate
• Reducing the role of the state in the economy
through privatization and reduced government
spending 19
The Structuralist perspective
• The Structuralist perspective is based on the
theory of dynamic comparative advantage
• It dictate that neo-liberal analysis inapplicable
and misleading for LDCs
• It emphasize the need for a conscious and home
tailored and specific industrialization strategy
and policy package
• The following are underlying features of
structuralist approach
Skepticism about the beneficial effects of
unadulterated free market 20
Emphasis on structural change
Emphasis on the dynamic aspects of technology
Capital accumulation and investment in
productive sector
Ownership and control of resources
Structuralist policy prescription
The state in LDCs should pursue active strategic
interventions in order to promote
industrialization
• Infant industry Promotion
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• Priority setting
• Coordinating complementary & substitutable
investments
• Efficient scale operation
• Ownership and structural change of industries
• Structure of the industrial sector
• Technology transfer
• Foreign investment monitoring & control
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