Global news of industrial policy’s demise was vastly exaggerated

The only significant policy initiative that the post pandemic Indian economy has seen from the Government has been an openness to use Industrial Policy as a tool for economic development. This has predictably elicited howls of protest and indignation from Economists who have classified this “inward” view of the economy as a violation of the Washington Consensus which recommends free trade, strong institutions and a mildly indifferent government as the only cure to poverty and destitution in less developed economies. India’s policy initiatives, radical by historical standards, have been criticized on three main grounds. One, Industrial Policy has historically failed. Second, Industrial policy fails because bureaucrats can not allocate resources as well as markets can and hence can’t pick “winners”. And, lastly, because of the above two reasons Industrial Policy is essentially a “Freebie” scheme that allows large industrialists/monopolists to extract rents from the state.

While these arguments are repeated ad nauseam at every forum, very little evidence is provided to support them. Let us first look at the first assertion that Industrial Policy has failed historically. This argument is backed by pointing to the rapid improvement in living standards of many countries (largely Western) under a free trade regime. There are several flaws in this argument. The primary one being that for a less developed country to draw lessons from developed countries, it should look at policies employed by developed countries when they were underdeveloped and not when they had already Industrialized. Empirically speaking all advanced economies have employed Industrial Policy aggressively and sometimes violently to achieve industrialized status.

While this holds true for all developed countries, in the interest of space, let us look at the case of the two bastions of free trade and capitalism, the UK and the US. No Industrial policy tool is as hated and scorned by free trade economists as Tariffs. Yet both the UK and US were heavy users of tariffs to protect their infant industries when they were underdeveloped. In a brilliant book, “Kicking Away the Ladder”, Ha Joon Chang shows that average import tariffs on manufactured goods in the UK were 55% till 1820 when the UK acquired technological and industrial dominance over the world. A key feature of the UK tariff policy was to allow duty free import of raw materials but impose heavy tariffs on finished goods to encourage value addition in the UK. Heavy restrictions were also imposed on finished imports from colonies like India (Calico Act) and British merchandise was given duty free access to Indian markets in the spirit of 18th century “Free Trade”. The result was the total decimation of the Indian Textile Industry which at that time was widely acknowledged as the most sophisticated in the world and the emergence of Manchester as a textile cluster with 45% of British textile exports going to India. Many other non-tariff instruments were also used to promote domestic industry such as the Navigation Act which mandated that trade with Britain must be conducted on British ships.

Perhaps no other country in the world has used tariffs for industrialization quite like the land of the free - The United States of America. In fact, so pervasive was Industrial Policy in the 19th and early 20th century US that Economic historian Paul Bairoch calls America the “Mother Country and the Bastion of Protectionism”. Alexander Hamilton, one of the founding fathers of America and the first Secretary of the Treasury wrote a magnificent treatise on Industrial Policy in general and Tariffs in particular as a tool for development and christened it “The Report on Manufactures”. America doggedly followed the treatise for much of its history and had close to 50% tariffs on manufactured goods till 1940s when its Industrial dominance became unchallenged and it could afford to promote “free trade”. In 1875, the US had a per capita GDP that was 3/4th of the UK, then the richest country in the world and yet it had tariffs of 50%. Compared to this when India joined the WTO it had to bring down its Tariffs to 32% despite having a per capita income that was a tiny fraction of the US.

Another feature of the US Industrial Policy was the theft of technology and weak copyright laws. Free Trade economists have the knack of getting their knickers in a twist over violation of IPR by less developed countries like India. Yet the US till 1891 (when it was relatively rich) did not acknowledge foreign copyrights and US “inventors” could make merry with foreign technology behind a protective tariff wall. These anecdotes do not even scratch the surface of the scale and scope of Industrial policy that was employed by developed countries when they were in the same or even much higher state of development than India. Even now, not taking into account the half a trillion of Industrial subsidies through the recently promulgated IRA and CHIPS Act, America spends close to 1% of its massive 23 trillion GDP on Industrial policy. In fact, an oft repeated quip about American Industrial Policy is that America’s greatest Industrial Policy is to convince the world that it does not have an Industrial Policy.

In sum, unlike free trade economists would have us believe, Industrial policy is not back in fashion. This is because Industrial policy was never out of fashion. It was and remains an integral part of any country’s development strategy. Doubts about its utility are quite misplaced since the greatest economies of the world have used it and continue to use it aggressively. There are several examples of countries that have failed to develop without a coherent Industrial policy (India) but no example of a country that has achieved advanced status without it. The standard strategy followed by these advanced countries has been to use Industrial policy to achieve technological dominance and then advocate free trade from a position of industrial suzerainty to the detriment of less developed countries like India.

While India is late to this game, a coherent Industrial policy is critical to our ambitions. The second part of this article will explore in detail the strategic design of Industrial policy and features/instruments of Industrial policy that differentiate resounding success (Japan, Korea, Taiwan) from pleasant mediocrity (Thailand, Malaysia) and lessons for us from these cases.

Diva Jain is a director at Arrjavv and a ‘probabilist’ who researches and writes on behavioural finance and economics.Her Twitter handle is @DivaJain2.