Will the new industrial policy work?

Industrial policy has returned to government agendas across the developed and developing world. While the US Inflation Reduction Act has shocked America’s Asian and European trading partners, the Biden administration’s signature climate-change legislation is just the latest in a series of recent policies that seemingly fly in the face of World Trade Organization rules.

At a time of growing economic and political uncertainty, it is hardly surprising that governments are increasingly embracing industrial policy. Massive government intervention, after all, underpinned East Asia’s “economic miracle” between the 1960s and 1990s. Political scientist Chalmers Johnson attributed Japan’s postwar economic boom to the Ministry of International Trade and Industry, which dominated Japanese policymaking from 1949 to 2000. Similarly, economist Alice Amsden argued that South Korea’s transformation into an economic powerhouse relied on subsidies and tariffs that encouraged the formation of giant, state-backed industrial conglomerates. Despite the contributions of industrial policy to the East Asian growth miracle, the rise of neoliberal economics in the West made it taboo there. That began to change in 2008, however, as the global financial crisis created a seemingly insatiable appetite for government intervention. Faced with a rapidly growing China and a looming climate catastrophe, economist Mariana Mazzucato and others have reimagined industrial policy as a way to achieve a mission-oriented innovation economy guided by an entrepreneurial state. But industrial policy’s fall from grace in recent decades reflected its own shortcomings, not just a rightward ideological shift. Japan’s failed efforts to promote domestic aircraft production in the 1970s, for example, showed that governments are not always good at picking winners. For today’s industrial policies to be effective, governments must learn from the past and avoid two common mistakes. The first is shielding domestic companies from market discipline. Malaysia’s failed effort to build an internationally competitive automotive industry around the national car company Proton is a cautionary tale. In the 1980s, Proton gained a monopoly in the Malaysian car market thanks to various subsidies and tax benefits. But because government support insulated the company from market discipline, it never managed to meet the quality standards needed to become a global brand. Another mistake is overreliance on foreign ownership. Thailand and South Africa used financial incentives to lure foreign car producers to work with local manufacturers. But while their automotive industries have been more successful than Malaysia’s, they are also limited to producing lower value-added components; the higher value-added activities, such as research and development or the production of engines and transmissions, remain in foreign companies’ home countries.

China’s thriving car industry underscores the importance of nurturing local entrants. In the 1980s and 1990s, the Chinese automotive sector relied on technology transfers via foreign-owned joint ventures like Shanghai-Volkswagen. But after that strategy failed to produce the desired outcomes, the Chinese government pivoted to investing heavily in domestic manufacturers such as Chery, Geely, and BYD, enabling them to emerge as global players.

By combining financial incentives with market discipline and local ownership, policymakers can ensure that the industries they want to promote are competitive. The evolution of South Korean car manufacturer Hyundai is a case in point.

In the 1970s, Hyundai’s domestic lead was protected by high tariffs. But when the company exported its Pony model to North America, the car became notorious for failing to meet even basic quality and emissions standards and could not compete with comparable French and German models. This failure, together with robust domestic profits, encouraged Hyundai to invest in R&D and eventually expand global production. South Korea’s industrial policy soon shifted from protectionism and financial incentives toward public-private joint R&D, enabling local producers to gain the technical knowhow needed to expand into high-end products. Mobilizing private-sector participation from the beginning and creating viable markets are crucial to industrial policies’ success. In 2008, for example, the South African company Optimal Energy unveiled an electric vehicle called Joule that was funded almost entirely by government investments.

The five-seat car was well-received at that year’s Paris Auto Show and won the Best on Display award at the Geneva Motor Show in 2010. But local manufacturers deemed it too expensive to commercialize, given the small size of the electric vehicle market at the time and the steep cost of producing it at scale, and the project was abandoned in 2012. Vietnam and Turkey offer two other models of encouraging EV production. Vietnamese car manufacturer VinFast, for example, abandoned gasoline-fueled cars last year to focus on EVs. It reportedly sold 23,000 cars in 2022, with sales undoubtedly boosted by government tax credits to buyers. VinFast, a subsidiary of Vietnam’s largest business conglomerate, Vingroup, is reportedly planning to enter the US market by building a $2 billion factory in North Carolina. Turkey, where the Automobile Joint Venture Group (TOGG) recently launched the first locally-made EV, offers another interesting case.

TOGG, established in 2018 as a joint venture to develop a viable domestic car industry, is planning to produce 18,000 cars this year and up to 175,000 vehicles annually within the next five years. Turkish President Recep Tayyip Erdoğan, who is up for re-election in May, is reportedly heavily invested in the project, which he touts as the “people’s car.” Given the urgency and scale of the challenges posed by climate change, the next decade will likely be characterized by increased state intervention in the economy. But policymakers must remember that successful industrial policies are not about picking winners. They are about picking good students and providing them what they need to grow and prosper. Copyright: Project Syndicate, 2023