Published on 8 July 2024
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Doing industrial policy right: the pitfalls of protectionism

Past successes and failures of industrial policies highlight the importance of export-oriented (EO) strategies over import substitution (IS). EO policies, exemplified by the Asian miracles, leveraged global competition to drive efficiency and innovation, while IS policies often led to inefficiency and corruption. Fuad Hasanov and Reda Cherif argue that successful industrial policy requires a comprehensive approach, including competition, accountability, and long-term commitment, with a focus on future industries rather than past ones.

Since the 1980s, industrial policy has been considered a fringe idea in policy and mainstream academic circles but has recently staged a return in the public debate. The “Washington Consensus” emphasised free market reforms, liberalisation, and privatisation, but the pendulum seems to be swinging toward a more activist state. More recently, the three largest economic blocks in the world, the US, EU, and China, have started implementing major industrial policy packages. These policy initiatives target advanced industries such as microchips and green technologies but increasingly include protectionist elements such as tariffs. Should protectionism be an integral part of industrial policy packages, or as Gillian Tett recently inquired in the Financial Times column, how do we tell good industrial policy from bad?

In this revived debate, the interpretation of past industrial policy experiences of successes vs. failures can be helpful. Those in favour of state intervention to promote certain sectors usually lean on the example of the Asian miracles such as Korea, which achieved high sustained growth using activist policies such as cheap loans and subsidies, along with high tariffs and other protectionist policies. Others would point to the experience of many developing countries in the 1950s-1970s, which tried to create new industries, often beyond their capabilities, through a mix of subsidies and protectionism. For the most part, these experiments ended without success in the 1980s and 1990s, often leading to financial crises. In retrospect, it is perhaps not surprising that these failures led to industrial policy being associated with failure.

We argue in our recent paper, “The Pitfalls of Protectionism” that the diverging outcomes of the industrial policy strategies of the past stem from their fundamentally different market focus—inward-looking or Import Substitution (IS) industrialisation vs Export-Oriented (EO) industrial policy. Although the Asian miracles used the full arsenal of state intervention tools, including high tariffs to protect domestic markets, the main priority of their strategy since the onset was to target export markets, especially advanced markets, along with moving into more sophisticated industries while enforcing competition and accountability for the support given to firms. In contrast, industrial policy in many developing countries in the 1960s-1970s can be better described as import substitution policies. It broadly consisted in developing new industries, typically heavy industries such as steel and petrochemicals (although sophisticated industries like automotive were also targeted), and focused almost exclusively on the domestic market by protecting the final product from foreign competition.

Historically, export orientation was a critical element of a successful industrial policy as it achieved several key objectives. These are: (i) a market signal—it provided the state and firms with a continuous market feedback, free of the distortions that protected domestic markets usually have; (ii) fierce competition—competition in global markets forced domestic firms to focus on efficiency and productivity gains and innovation to keep up with the technological frontier and stay competitive; (iii) spillovers—it gave incentives for deeper value chain integration domestically and globally resulting in positive spillovers to and competitive and innovation pressures on other domestic firms; (iv) market size—it provided a market large enough to take advantage of economies of scale (firm size) and scope (a greater variety of products); and (v) accountability—it created incentives that could potentially mitigate corruption as firms need to compete globally to survive.

In contrast, IS policies tended to be easier and cheaper to initially implement, but any short-term “successes” hid long-term costs in terms of learning and sustainability in addition to the cost to consumers. Tariffs were easier politically to put in place, bringing in fiscal revenues, although often accompanied by implicit and explicit subsidies. Protected firms increased production, local content and some domestic supplier base, employment, and ultimately be very profitable. Meanwhile, they lacked the incentive to catch up with the technological frontier, innovate, and achieve an internationally competitive cost structure. Moreover, the market signal of how firms were doing was distorted because the domestic market was protected, and more important, corruption and cronyism were often rampant as competition was curtailed and profits stayed high.

The automotive industry in emerging markets is a good example of the historical experience with IS and EO industrial policies. Despite its huge market, India’s period of quasi-autarkic IS in the 1950s and 1960s, led to a domestic auto industry frozen in time, producing inefficiently the same car models for decades. Brazil, in contrast, used its large market to lure multinational corporations to a protected market while enforcing drastic local content requirements. However, the expected local spillovers remained limited, and the production cost structure and quality lagged the international standards. Malaysia protected its domestic market to nurture a national champion, which, after decades of protection, still relied on implicit and explicit subsidies and imports of critical inputs such as the motor engine. In contrast, in Korea, car companies initially received massive state support, but they were essentially forced to export from the onset. While the domestic market was protected to generate rents for producers at the expense of consumers, essentially all the chaebols (conglomerates) set up automotive subsidiaries, competing fiercely among themselves in the domestic market. Eventually, only one company survived as it vigorously competed domestically and internationally by innovating, optimising costs, deepening the domestic value chain, and increasing its global market share. 

The auto case study illustrates that policymakers in emerging markets set to support industrial development do not need to choose between “laissez faire” and protectionism when an export-oriented industrial policy is feasible. An attempt to follow in the footsteps of the Asian miracles does not entail replicating every aspect of their policies but extracting the key lessons or principles. We argue that their protectionist policies were not instrumental to their success, and they were only a part of their all-in approach to grow their industries. Rather, it was their laser focus on exporting and gaining market shares abroad that drove their success.

What else can we learn from the use of industrial policies for development purposes at the time of the Asian miracles? Although export orientation is superior to import substitution and protectionism, it also requires a comprehensive policy package implementing the key industrial policy principles. The principles of competition and accountability for the support received with a focus on sophisticated sectors were another key to success. In addition, where successful, industrial policy also made full use of available fiscal, regulatory, and financial tools, and policymakers continuously tweaked policies, closely coordinated with the private sector, and showed patience beyond the electoral cycles and a tolerance for failures. Long-term success came from betting on the industries of the future instead of protecting those of the past.

The views expressed are those of the authors and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Working paper: The pitfalls of protectionism: import substitution vs export-oriented industrial policy

The views and opinions expressed in this post are those of the author(s) and not necessarily those of the Bennett Institute for Public Policy.


Reda Cherif

Affiliated Researcher

Reda Cherif is a Senior Economist at the International Monetary Fund (IMF). He joined the IMF in 2008. His research covers development economics, natural resources, industrial policy, and growth and...

Fuad Hasanov

Affiliated Researcher

Fuad Hasanov is a Senior Economist at the International Monetary Fund (IMF) and an Adjunct Professor of Economics at Georgetown University. Before joining the IMF in 2007, Fuad was an...

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