Between 1960 and 1989, South Korea witnessed an exceptional economic expansion, widely recognised for its real GDP per capita increasing at an impressive annual average of 6.82 per cent. This phenomenal growth has frequently been credited to the nation’s industrial policy, which involves governmental support directed specifically at specific industrial sectors. In this instance, it is commonly believed that such policies were the driving force behind decades of robust economic growth.
However, the actual impact of industrial policy on overall GDP growth is under scrutiny. A pioneering study conducted by four academics, including two economists from MIT, proposes that the contribution of industrial policy to GDP growth is considerably modest. The study uses global trade data to evaluate shifts in industrial capacities across various countries. Findings suggest that, in the most favourable scenarios, the industrial policy could boost long-term GDP by merely 1.08 per cent and, at most, by 4.06 per cent when additional conducive factors are present. These figures starkly contrast with the annual growth rate of 6.82 per cent previously recorded, indicating a much lesser benefit than anticipated.
The significance of this study extends beyond the mere figures; it explores the underlying reasons for these outcomes. It highlights, for example, how local consumer demand can significantly limit the effectiveness of industrial policy. Changes in production output, influenced by government policies, might lead to a different shift in consumer demand for these goods, thus capping the potential growth that can be directed through such policies.
MIT economist Arnaud Costinot, a co-author of the study, remarked on the findings, stating that while the gains from industrial policy are present, they are not monumental. “In most cases, the gains are not going to be enormous,” Costinot explains. He further noted that these gains do not match the full extent of growth seen in South Korea, which is often cited as a quintessential example of successful industrial policy.
The research integrates empirical data with economic theory, particularly assessing conditions deemed ideal for industrial policy according to economic textbooks. Another co-author, Dave Donaldson, also from MIT, suggests that while industrial policy may have played a significant role in the success stories of countries like China, Japan, and even the USA, the textbook arguments only partially account for these successes. “The question is whether the textbook argument for industrial policy fully explains those successes, and our punchline would be, no, we don’t think it can,” Donaldson elaborates.
The study, “The Textbook Case for Industrial Policy: Theory Meets Data,” was published in the Journal of Political Economy. In addition to Costinot and Donaldson, the authors include Dominick Bartlelme, an independent researcher, and Andres Rodriguez-Clare, a professor of Economics at the University of California, Berkeley.
The researchers used global trade statistics to glean insights into changes in sector-specific capacities within countries and other economic metrics to evaluate the broad impacts of industrial policies. If specific industries expand and become more productive, this should be reflected in increased export volumes, thereby indicating productivity gains. This method of reverse engineering offers a unique empirical approach to understanding the scale effects of industrial policies.
The study examined data across 61 countries, encompassing various timeframes over recent decades and including exports from 15 manufacturing sectors. The calculated average long-term GDP gain from industrial policy stood at 1.08 per cent, with individual countries experiencing benefits ranging from 0.59 to 2.06 per cent annually under favourable conditions. Small, trade-open countries might see more considerable proportional benefits.
Additionally, the research points out that while there is potential for redirecting economic activity through industrial policy, the scope for such redirection is limited by relatively fixed demand levels. This implies that even if a sector could expand significantly due to government support, actual growth would eventually stagnate as the market becomes saturated.
In discussing the broader implications of industrial policy, Costinot and Donaldson also touch upon various factors that governments might consider when adopting such policies, including wage distribution, environmental concerns, and geopolitical strategies. In places like the USA, industrial policy has been considered a means to rejuvenate deindustrialised areas and re-skill workers.
Ultimately, the study does not conclude definitively on the efficacy of industrial policy but instead deepens the understanding of its dynamics and potential limitations. While broad gains from such policies may be limited, targeted interventions in specific sectors and regions could yield substantial benefits when conditions are favourable. Policymakers are encouraged to realistically assess the potential growth outcomes of industrial policy, recognising that while significant gains are possible, they may only sometimes align with the theoretical maximums posited in economic textbooks.
More information: Dominick Bartelme et al, The Textbook Case for Industrial Policy: Theory Meets Data, Journal of Political Economy. DOI: 10.1086/734129
Journal information: Journal of Political Economy Provided by Massachusetts Institute of Technology