structural change, encouraging the search for new business models and markets, and channeling resources into promising and socially desirable new activities.
Evidence of failed industrial policy experiments, however, is also abundant. Hence, while market failure justifies public intervention in principle, inappropriate policies may have worse results than non-intervention.
The question is thus not whether industrial policies should be adopted or not, but how they can be implemented more effectively – an especially challenging question for late comer economies, where market failure is particularly common. Government action is required to form even the most basic market institutions, such as creating a national entrepreneurial class and encouraging the formation of business associations.
At the same time, the effectiveness of the state is typically low, and the risks of political capture are considerable as the political systems often build on favouritism and lack political checks and balances.
Our study of industrial policy in low and lower-middle-income countries revealed examples of success and failure. It confirmed that industrial policies may be implemented successfully even in low-income countries with weak institutions, but it also identified a number of failed policies or at least raised doubts about cost-effectiveness.
Generally, most policies deviated considerably from the good practice principles described earlier on. Both the positive and negative observations, however, allow us to extract seven key lessons for industrial policy in low and lower-middle-income countries.
First, the political leaders must have the firm will to pursue a national project of productive transformation aimed to diversify their economies and develop new competitive advantages in higher-value activities.
As such activities usually require a range of assets unavailable in poor countries; they are unlikely to emerge spontaneously without a coordinating agent (or they only emerge slowly compared to international competitors who pursue a proactive strategy).
Governments must therefore coordinate competent ministries and implementing agencies, public and private actors, central and local governments as well as the support of international donors.
Second, these transformation projects need to build on existing comparative advantages and define incremental upgrading pathways that are manageable for the relevant national actors.
Very ambitious targets may overestimate the learning capacity of the domestic private sector – and/ or the supporting institutions – and thus waste government resources.
It should be noted, however, that the opposite of industrial policy – wholesale liberalization – may also overburden domestic entrepreneurs, with the effect that importers and foreign investors destroy the embryonic technological capabilities that exist.
The key is to increase competition and apply non-market incentives in a way that induces the private sector to upgrade without overstraining its capacities and without creating unproductive rents.
Third, the transformation should balance economic, social and environmental objectives. Low and lower-middle-income countries are typically characterized by deep and even widening productivity gaps.
The lack of productive integration of large parts of the workforce perpetuates poverty and forgoes opportunities for inter firm specialization that would make the whole economy more competitive.
Unless productive integration is proactively supported, competition on an uneven playing field typically crowds out large numbers of less efficient producers and destroys traditional jobs without being able to create a comparable number of employment opportunities in the emerging, more efficient, activities.
The desirable effect of creative destruction then tips over, leading to a detrimental increase of necessity entrepreneurship and informality.
Liberalization must therefore go hand in hand with targeted and temporary protection as well as proactive policies for knowledge transfer and capacity building.
Again, the challenge is to encourage productivity growth at a pace that allows for integration of local producer groups and protection of the most vulnerable groups. Likewise, environmental sustainability needs to be built into industrial development strategies.
As the world will increasingly shift towards a low carbon economy, even countries with low per-capita emissions will be affected. Governments are therefore well-advised to anticipate these changes and to try to exploit early mover advantages.
Fourth, these optimal upgrading pathways – in terms of manageable incremental steps, social inclusion and environmental sustainability – can only be identified if industrial policy is devised as a collaborative process of experimental learning, involving stakeholders and ensuring feedback loops between planning, implementation and impact measurement.
Policies need to be agreed upon in a collaborative manner, inviting the private sector, public entities and civil service organizations to bring in their expertise.
Public funds should usually be matched with private contributions to make sure that beneficiaries have ownership for the respective programmes.
Implementing agencies should operate in a business-like, customer-oriented manner, and hence be authorized to recruit and promote personnel based on performance criteria.
Fifth, the focus of industrial policy should shift from promoting established firms in traditional industries to supporting innovative ideas and encouraging experimentation.
There is a strong case for subsidizing the search costs of innovators, because testing a new business concept involves costs and risks of failure.
Poor developing countries are typically characterized by segmented enterprise structures, with few linkages between different groups of enterprises, such as foreign invested firms, large national firms, and micro and small firms. Large productivity gaps impede integration of the latter in specialized business networks; in order to exploit economies of specialization and stimulate knowledge spillovers.
Regional economic integration is one way of improving investment and trade opportunities in an environment that is often not as challenging as the world market.
Regional integration calls for a greater emphasis on regional infrastructure projects, international harmonization of economic governance as well as reforms to reduce other costs of trading across borders.
Beyond these general lessons, a good deal of trial-and-error learning is needed to find the most appropriate industrialization pathway for each particular country.
Some low and lower-middle-income countries have embarked on promising, albeit different, pathways, despite relatively low levels of government effectiveness and weak political checks and balances.
More research is needed to fully understand the political economy behind these processes, i.e. what moves political leaders, or growth coalitions, to embark on national projects of productive transformation and what explains their different willingness and ability to manage the risks of political capture.
Muharram Macatta is a retired civil servant. He can be reached on +255 755 167 620. Email: [email protected]