As I have been an advocate for industrial policy for many decades, even when many of my economist friends were gung-ho liberalisers on trade policy, I am now often asked about my opinion on the industrial policy being currently adopted by the Indian government.
While in the past I had studied, with some appreciation, the experience of industrial policy in East Asia (Japan, South Korea, Taiwan and later China), my advocacy of it in countries like India has all along been somewhat qualified by healthy skepticism about its implementation by a heavy-handed bureaucracy.
First of all, the industries need to be very carefully selected. Many of the industries currently chosen to be under PLI (production linked incentives) are highly capital- and skill-intensive. So the goal of job creation for our massive numbers of unskilled workers is unlikely to be met. Even in Japan and South Korea, where industrial policy has been otherwise successful, it has often mainly helped large firms. But for creating jobs, the focus has to be on small and medium-scale firms.
Of course, job creation or even economic growth may not always be the main goal of industrial policy. In a world of geo-political conflicts and supply chain disruptions, national security is often considered a major goal. But even in view of this goal, I think the plan of giving a 50 per cent subsidy (amounting to $10 billion) to Vedanta-Foxconn for fabricating chips is difficult to justify. Processing silicon downstream would have been more consistent with India’s productive capacity and would have also created more jobs. For many years even the US has concentrated more on chip design than on fabrication of advanced chips (leaving those to Taiwanese and South Korean firms).
In policy implementation one has to be particularly vigilant in monitoring the performance of the target firms, be strict with non-performing firms, and, if necessary, withdraw support from them. Like venture capitalists in the private sector who constantly monitor start-up firms they support and withdraw support when necessary, officials have to play the role of “venture bureaucrats” in the terminology recently used by The Economist.
This often requires making an extra effort to go beyond the traditional hidebound bureaucratic culture in India. One has to be especially careful in disciplining firms that are being supported, lest they become white elephants or they acquire too much market power (in the Indian context of already exceedingly high corporate concentration), or crony corporates are subsidised to go into new lines of business they’d have gone anyway, as is now common in India.
In East Asia’s recent history, South Korea and Taiwan used the discipline of success in export markets to prod the firms supported by their industrial policy to keep to international standards of quality and cost-consciousness. They followed a stick-and-carrot policy: The stick of export market discipline and the carrot of generous credit subsidies.
In general, there is now solid empirical evidence in policy literature that industrial policy succeeds more when it is oriented to the discipline of market competition. In a 2015 article, Philippe Aghion and co-authors cite panel data from medium and large Chinese enterprises over 1998 to 2007 to show that industrial policies targeted to competitive sectors or policies that foster competition (say, policies that are more dispersed across firms in a sector or measures that encourage younger and more productive enterprises in a sector) increase productivity growth.
In a general survey of the literature on industrial policy, my Berkeley colleagues Ann Harrison and Andrés Rodríguez-Clare have recommended a whole range of “soft” industrial policies, not incompatible with WTO (World Trade Organisation) regulations (like encouraging research and development, extension services, vocational training, supporting collective action for self-help in business clusters, improving regulations and infrastructure, and so on), where the goal is to develop domestic policies of coordination that improve productivity more than interventions that distort prices.
Also, these soft industrial policies need to be customised to local decentralised contexts, particularly when you want to help small and medium sized firms. Unfortunately, Indian politicians and bureaucracy are more comfortable with “top-down” over-centralised policies.
Nevertheless it is important to reiterate that the usual objection of trade and other economists that industrial policy involves “picking winners” and that it is impossible for a government bureaucracy to do so is quite misleading. Here I endorse the following statement on industrial policy that the Harvard economist Dani Rodrik recently made: “In the presence of uncertainty, it is inevitable that some projects backed by the government will fail. In this respect, the government is no different from the private sector. The relevant question is whether enough of the projects backed by the government will succeed and produce the social surplus to pay for the failures (and more).” The other relevant question, of course, is if the government will have the ability to withstand pressure from the concerned lobby to prolong a failed project.
Going back to the job-creation goal, the 2017 United Nations publication on Green Industrial Policy suggests many examples of new green products and service opportunities that have a great deal of job-creating potential. Apart from renewable energy technologies (solar, wind and geothermal power) both in generation and storage, the focus needs to be on examples like bioplastics, decentralised miniature electric grids, technologies of drip irrigation and rainfall harvesting, the reinforcement of sea walls, green energy-powered three-wheeler public transportation, and so on. So support for industrial policy has to be nuanced, multi-faceted and vigilant in its disciplining functions.
The writer is Distinguished Professor, Emeritus, of Economics at University of California, Berkeley
