Industrial policies have returned. What’s new?

But it was exactly India’s trade measures that hit the headlines in early-August, when it imposed licencing requirements on the import of computers, a move it back pedalled on somewhat in the face of protests. Ultimately, the government delayed the introduction of the measures by three months, but didn’t reverse it.

Many observers were quick to point out this measure was not an isolated one. In the last few years, after a steady downward trend for many years, India has been increasing its tariffs. The World Trade Organization (WTO), in its review of India’s trade policy for 2021, pointed out that since the previous review in 2015, the country’s simple average tariff rate had increased from 13% to 15.4%.

The number of goods with tariffs below 10% declined to 67.8% of the overall trade basket in 2020-21, from 79.1% in 2015. By comparison, the share of goods with tariffs between 10% and 30% increased to 22.1% of the overall trade basket in 2020-21, from 12.1% in 2015.

In a paper in 2020, Shoumitro Chatterjee and Arvind Panagariya, noting that there had been about 3,200 tariff increases done by India since 2014, said: “India is turning inward. Domestic demand is assuming primacy over export-orientation and trade restrictions are increasing, reversing a three-decade trend.”

According to the Global Trade Alert database, which tracks trade policy measures across countries, India has seen a spike in trade measures that could be seen as ‘harmful’ to trade, since at least the last decade. While there is data available for close to 280 sectors, close to one in seven ‘harmful’ trade policy measures have been seen in six sectors—precious metals, jewellery, vegetable oils, oilseeds, organic chemicals and metal waste/scrap.

Union minister of state for entrepreneurship, skill development, electronics and technology Rajeev Chandrasekhar tweeted that by licencing imports of IT hardware, it was the government’s objective to ensure “trusted hardware and systems” while also reducing India’s dependence on imports and increasing its reliance on domestic manufacturing. In other words, this was a form of industrial policy, in all but name.

The classic argument against industrial policy—broadly defined as a set of policy measures aimed at large-scale changes in the structure of the economy—has been broadly two-fold. First, economists argue, governments are terrible at predicting the future. Bureaucrats are bad at identifying future economic trends or industries (let alone companies) to promote, which will ‘take off’ in the future and pull the rest of the economy along with them. Secondly, even if governments could do this, there is the risk that any benefits that governments offer will be snapped up by politically well-connected business groups rather than the dynamic, under-funded entrepreneurs who really need it and will put it to good use.

So, are the ‘new’ industrial policies any different?

A global trend

While much criticism has been directed at the Indian government for appearing to be more trade ‘interventionist’ in recent years, the reversion of many countries to some form of ‘industrial policy’, which effectively aims at replacing imported products with domestically produced ones, is a global phenomenon. A recent paper by Réka Juhász, Nathan J Lane and Dani Rodrik on the return to industrial policy uses data compiled for countries on trade and industrial policy measures implemented by governments across the world, using official documents. It concludes: “Industrial policy has indeed returned and is on the rise.”

The total number of policy interventions classified by the database relating to industrial policy rose from 56 in 2012 to 1,568 in 2022 (chart 1). Importantly, they note, high-income G20 countries are major users of industrial policy, with advanced countries accounting for the “overwhelming majority” of industrial policy interventions (chart 2). This is partly because while industrial policy is implemented in various different ways, an important avenue is the government budget—either as subsidies or as tax concessions. Richer countries have much more financial leeway to spend a greater proportion of their budget on such policies.

Interestingly, the authors conclude that import tariffs are not the main tool of industrial policy—the trend in import tariffs provides only a partial picture of industrial policy measures. The most obvious example of this in India’s case is the ₹1.97 trillion production-linked incentive (PLI) scheme. On the face of it, the PLI scheme has nothing to do with tweaking tariffs. It is focused on incentivizing companies to increase domestic production across 14 sectors, rather than manufacture products outside India.

Another important category of industrial policy measures across richer, middle-income, or poorer countries attempt to lower cost of production for companies through a variety of means—loan guarantees, trade finance, loans from the state, or even outright grants. Finally, even in the case of trade, the so-called non-tariff barriers to trade—governments setting minimum quality standards for imports, for example—have become progressively more important in influencing trade flows.

Some sectors stand out prominently when it comes to industrial policy. Green energy in general, and electric vehicles in particular, are sectors that many governments give attention to. The auto sector is another example. Among poorer countries, textiles and apparel figure prominently as sectors targeted for incentives.

Spot the change

So, how is the new industrial policy different? Contemporary industrial policies, the authors argue, are much less inward looking. They are aimed at blocking off imports, but much more focused on promoting exports. An industry focused on winning export orders is likely to be much more cost-efficient and uses the latest technology than one that knows it can operate safely in a sheltered domestic market with few competitors.

In an important sense, of course, this is hardly ‘new’ industrial policy. The tiger economies of Asia—starting from Japan, followed by South Korea, Taiwan and others, and finally China—did exactly this. By doing so, these countries have effectively set the standard for what is ‘good’ industrial policy and what isn’t.

But even trying to identify what is, and what isn’t, an industrial policy can be difficult. For instance, a month before the laptop licencing restriction, India imposed import licencing requirements on gold jewellery. This was hardly related to any aim by the government to promote a domestic jewellery industry, but an explicit attempt to close off a loophole which businesses were using to import gold without duty.

Thus, it’s critical to identify why governments are attempting to impose, say, a tariff or a licencing requirement, rather than to automatically assume that they are to protect domestic industry. Further, a government can target a single sector through a variety of industrial policy instruments over time. Some of these are measurable, like import tariffs. Others are unquantifiable such as ‘administrative guidance’—when bureaucrats sit down with companies and nudge them in a certain direction.

The difficulty of observing industrial policy is not just an academic issue. Governments, point out Juhász, Lane and Rodrik, cannot use many of the tools that were at their disposal decades ago to influence trade. Given the commitments to the WTO, for instance, few governments can raise import tariffs at will. So, import tariffs have become much less important a tool of industrial policy than in earlier decades.

Even the experiences of the successful Asian economies throw up different lessons, depending on which country we look at. Both China and Vietnam, for example, relied to a much greater extent on foreign direct investment (FDI) to promote domestic industry than their predecessors. China followed a model whereby foreign companies partnered with domestic companies, such as those in the auto sector, to set up manufacturing units. Over time, a process of skill and technology transfer would take place to the domestic partner. This form of quid-pro-quo FDI has proved controversial with foreign companies, who tend to view it as a form of forced technology transfer.

Nevertheless, as research by Jie Bai, Panle Jia Barwick, Shengmao Cao, and Shanjun Li showed, the quid pro quo FDI route led to auto models being produced in China with quality improvements of between 3.8-12.7%. Across East Asian economies, facilitating exports through the use of tools such as trade finance was ubiquitous and critical. And again, reliance on formal protective measures, so beloved of Indian policymakers, came down over time in East Asia and even in South Korea.

A critical aspect of the success of the Asian tigers was the relationship between state and industry. It was neither top-down—an approach that would effectively result in the government ordering the private sector around and telling them where to put their money. It was also not too clubby, which would have resulted in the ‘political capture’ of the state by industry. Bureaucrats worked closely with industry and there was constant feedback from industry to government about what was working and what wasn’t. Thus, governments were able to be pragmatic and constantly improve policies which worked and throw out those that didn’t.

The other major policy that works is just better infrastructure—better roads, better ports, better and more reliable power supply. In addition, better targeted infrastructure investment that directly addresses the needs of manufacturers and entrepreneurs, rather than being the vanity project of a prime minister or president.

The new context

The context in which industrial policy is done has changed dramatically from a few decades ago. The biggest change is the actual decline in manufacturing across the world as a source of growth of GDP and of employment. Even in China, manufacturing employment has been declining since at least 2014.

If a core goal of industrial policy is employment, then by definition, industrial policy will have to focus on services to a much greater extent than it has. “So, the question becomes whether the productive development policies typically applied to manufacturing can also be appropriate for sectors such as retail, hospitality, education, healthcare, or long-term care,” write Juhász, Lane and Rodrik. “But good-jobs externalities (which lead to jobs that provide social mobility to the middle class) are rampant in such services, and we know that these activities can benefit from complementary investments in new work practices, job-specific training, technologies that complement and empower workers, better tailored regulations, and improved organizational culture.”

The contemporary debate on industrial policy in India tends to get caught up in the issue of ‘should we go down this road again’. This is essentially irrelevant. All governments use such policies and they always will. The questions should really evolve around what policies to use, what sectors to target, and how to set up a mechanism by which governments learn from the experience of private industry and adapt.

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