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Business News/ Opinion / Views/  Adopt clear evaluation criteria for industrial policies

Adopt clear evaluation criteria for industrial policies

We must agree on how best to measure their success or failure for a proper debate on their value

The US has launched its industrial policy to ensure that it has enough domestic production capacity in its three selected areas of infrastructure, semiconductors and clean energy. Premium
The US has launched its industrial policy to ensure that it has enough domestic production capacity in its three selected areas of infrastructure, semiconductors and clean energy.

It has been a year since US President Joe Biden signed the Inflation Reduction Act into law. The new legislation goes beyond the goal of price control stated in its name. The Inflation Reduction Act works in tandem with other new legislative proposals such as the American Rescue Plan and the CHIPS and Science Act to pivot the US towards active government intervention in industry, through direct investments, tax credits, subsidies and some import tariffs.

A senior economist in the Biden administration has written a lucid policy brief to mark the first anniversary of the Inflation Reduction Act. There are four salient points in her note. First, US industrial policy is very tightly focused on three areas: infrastructure, semiconductors and clean energy. Second, the government will intervene with a combination of direct investments as well as incentives for companies. Third, the ultimate test for the success of these public investments will be whether private investments flow into the three areas that the government is focused on. Fourth, the report card for the new industrial policy should not be based on just shreds of descriptive data about how private investment is picking up, but on more rigorous causal analysis as evidence piles up over the years.

Washington’s industrial policy in the US is barely a year old. In contrast, Beijing’s ‘Make in China 2025’ programme is nearly a decade old. It was launched in 2015 as part of a larger strategic goal to guide the Chinese economy up the value chain, from being a developing country that was a cheap provider of industrial capacity to an advanced economy driven by innovation. The idea is to build capabilities in 10 industrial fields: next-generation information technology, robotics, aerospace, oceanographic equipment and high-technology shipping, advanced rail transportation equipment, electric vehicles, electric power equipment, agricultural machinery and equipment,new materials, and biopharmaceuticals and high-performance medical equipment.

How is it doing? There is scant research on this. One reason is that the Chinese government has never revealed which firms it is lavishing funds on as part of its ‘Make in China 2025’ programme. Economists Lee Branstetter and Guangwei Lee trawled through the annual reports of all listed Chinese company from 2015 to 2018 using text search algorithms to identify the beneficiaries of government largesse. Their broad conclusion after careful statistical analysis is that while the firms that received government subsidies to promote innovation did increase their research and development spending as a percentage of sales, there is little evidence of broader productivity improvements, patenting increases or higher profitability.

These results are only for the initial years of the policy, and before the tariffs imposed by the Donald Trump administration that Biden has not removed. There are two broader points here. First, the potential goals of industrial policy depend a lot on what a country sets out to do. Second, what a country should set out to do depends on where it is in terms of the global innovation frontier. Geopolitical calculations matter as well. The US has launched its industrial policy to ensure that it has enough domestic production capacity in its three selected areas of infrastructure, semiconductors and clean energy. China is struggling to pivot from its old model of export growth driven by capital accumulation and low-cost labour to an economy based on innovation and domestic demand.

The success rate of 20th century industrial policy is far lower than is commonly assumed. For every South Korea, there is a Brazil. The initial burst of Chinese growth that provided the necessary momentum for that economy came with falling import tariffs and very few sector-specific interventions by the government.

The new variant of industrial policy being introduced across the world over the past few years is too fresh to offer any convincing conclusions. Yet, it is worth asking what the metrics of future success or failure will be. These metrics matter for India as well. Here are possible ways to measure the impact.

One: Economic growth over the next decade is at least one percentage point higher than the previous two decades’ average.

Two: A meaningful increase in industrial production as a percentage of GDP. (The industrial policy launched in 2013 explicitly aimed at raising this measure by nine percentage points to 25% of GDP.)

Three: A substantial rise in the proportion of the labour force employed in factories.

Four: A structural shift in the trade balance, especially for countries such as India with high trade deficits.

Five: Lower dependence on China either as an export market or as a source for imports that go into domestic production as well as consumption.

Most debates on the impact of industrial policies—tax breaks plus import tariffs plus investment subsidies—are based so far on anecdotal evidence. Both the early success of American industrial policy as well as the early problems of Chinese industrial policy fall into this category. India is no exception. Most of the evidence on offer is either anecdotal or restricted to a few areas. The macro data as yet shows no structural shifts, though it is only fair to add that it will take many more years for more clarity to emerge. However, it is important to agree on some standard of measures of success or failure to give the debate on industrial policy some weight.

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Published: 22 Aug 2023, 09:53 PM IST
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