Industrial policy in a new global reality

Structural transformation is a key feature of economic development, and efforts to accelerate this process have been at the heart of many successful economic development strategies. Export-oriented industrialization has provided a way for unskilled agricultural workers to join the global economy. Connecting these workers with capital, knowledge and ultimately international markets was considered the tried and tested path towards convergence.1

But these dynamics are increasingly failing to deliver. Even where industrial output is rising, job creation in manufacturing is limited and productivity growth in manufacturing is outpacing demand. Just like their peers in advanced markets, large companies in developing economies are adopting capital-intensive technologies. Jobs are usually created by small, less productive and often informal manufacturing companies. Moreover, job creation is switching towards the service sector at a lower level of prosperity. These service sector jobs tend to be less productive and focused on serving domestic demand. Growth is harder to achieve without the leverage of serving foreign markets. And where natural resource exports or capital inflows provide external fuel to growth, growth dynamics tend to be fragile and exposed to global market shocks.

One distinct example of these dynamics is India. The share of the country’s working-age population has been increasing strongly and the Indian government has launched a range of ambitious policy initiatives such as “Make in India” to trigger growth in manufacturing. Still, job creation has been disappointing overall and is primarily driven by services.

How do development strategies need to be modified given these new circumstances? In a number of recent talks, Dani Rodrik outlines a path forward: he takes a fresh look at which sectors to prioritize to drive growth and frames the appropriate target as “middle-productivity” production activities. This, he argues, is a set of activities where jobs for low-skilled workers can be created while leveraging the potential of global export markets.

Yet there are other dimensions that are often overlooked in the debate about which sectors to focus on: first, the new strategies must recognize the need to reach different types of firms and to use with different types of policy instruments to succeed in doing so. In terms of firms, small and medium-sized enterprises (SMEs) become the critical focus of attention, not simply instead of, but alongside large multinational firms and leading national companies that have dominated much of the traditional industrialization debate. In terms of policies, a mix of ’softer’ policy interventions from market intelligence, vocational training, technical advice, mentoring, networking structures, common services and other customized business incentives become key. These are the tools needed to enable SMEs to create jobs that are increasingly productive and part of the formal competitive economy. This set of policies stands in contrast to the mix of subsidies, tax breaks and targeted trade protection that has characterized traditional industrial policies. These new competitiveness policies are more complex than just awarding small grants for SME development. They require government capacity to identify market failures and address them without creating market distortions. And they require implementation models that can have an impact at scale, something many traditional SME policies have struggled with.

Second, the new development approach must become more location-specific. SMEs’ distinct growth opportunities and upgrading needs are to a significant degree shaped by their location. Data from India reveal how much economic activity in specific groups of related industries or clusters is concentrated geographically. In textiles and apparel, for example, roughly 70 districts out of India’s 676 districts in total account for more than two-thirds of the national payroll. A closer look at individual districts shows that each of them has their unique cluster portfolio and locational characteristics, even among those that share strengths in specific sectors. In terms of policies, this requires deploying a location-specific set of actions, and thus also a location-specific institutional structure to identify local needs and implement actions in line with local circumstances. This is a significant change relative to the traditional policies geared towards accelerating structural change, which tend to be controlled at the national level.

At the intersection of sectors, SMEs and location, this new approach to drive structural transformation can build on a significant wealth of research, conceptual thinking and policy practice in cluster-based economic development. Cluster-based approaches are no simple panacea: a lot depends on how these programmes are structured. But they can be a useful tool for analysing prospects for growth and barriers that groups of SMEs in specific locations face.

Cluster approaches can help policymakers design and cost-effectively implement coherent action plans and policies that can unlock opportunities. The understanding of ‘what works’ is now markedly richer than in the early 1990s, when Michael Porter’s work triggered a first wave of cluster efforts. Examples of such policies come from places without a tradition of government-driven industrial policies such as Catalonia, the Basque Country, Denmark but also in a range of Latin American countries including Chile, Colombia and Mexico.

These policies are now also being applied in the US in the context of the Build Back Better regional challenge program and the investment in regional innovation ecosystems under the CHIPS act. They have informed a string of activities by the European Commission in support of the European Industrial Strategy. And such location- and sector-specific growth efforts are a core pillar of the recently released Competitiveness Roadmap for India.  

Cluster-based approaches provide unique tools to map entrepreneurial ecosystems, to conduct industry and value chain analyses, design sector-specific policies to indirectly support SMEs by addressing common market failures, and to implement them in a cost-effective, at-scale manner. Cluster-based approaches are primarily sector-specific in their policy focus to enhance productivity, and not sector-picking in artificially raising the profitability of specific sectors only. It is at this sectoral level that efforts to address market failures, for example investing in skills, technology and common infrastructure and to ensure that markets operate effectively, such as balancing existing market dominance through blockchain and other technologies, can be more effective than cross-cutting policies alone.

International institutions such as UNIDO have an important role to play in ensuring that this new era of sector- and location-specific efforts takes advantage of the best evidence and thinking available, overcoming some of the challenges that have hampered their predecessors in the past.

This piece has been adapted from a blog published on the World Bank Blogs.