Industrial policy

Industrial policy — government intervention to shape which sectors of an economy grow — is the most controversial topic in development economics. The IMF spent the 1980s-90s arguing it shouldn't be done; the World Bank reversed in the 2000s and now actively promotes it; the empirical record is mixed but contains real successes. This module is what we know about when and how it works.

Horizontal vs vertical industrial policy

• Horizontal — improving the general business environment that affects ALL industries equally. Infrastructure, education, contract enforcement, macroeconomic stability, regulatory simplification. Uncontroversial across the political spectrum
• Vertical — targeting specific sectors or firms for preferential treatment. Tax holidays, tariff protection, subsidised credit, public procurement preferences, R&D grants. Controversial because it requires picking winners

The IMF/World Bank consensus of the 1980s-90s was: do horizontal, don't do vertical. The post-2000 revisionist position (Rodrik 2004; Lin-Chang 2009; Cherif-Hasanov 2019): vertical can be done, IF you build the institutional capacity to do it well.

The East Asian developmental-state model

South Korea, Taiwan, Singapore, and Japan executed strong vertical industrial policy from roughly 1960-1990. Common features:

• Concentrated executive authority — a small cadre of insulated technocrats had real autonomy to set policy and discipline industry
• Industry-government coordination — formal mechanisms (Japan MITI, Korean Economic Planning Board) for ongoing dialogue with industry leaders
• Performance-conditional support — subsidies, cheap credit, and trade protection were conditional on export performance. Failures lost their support; successes got more
• Investment in skills and infrastructure — heavy public investment in primary, secondary, technical-vocational, and selectively in tertiary education
• Macroeconomic stability — low inflation, stable real exchange rates, prudent fiscal management
• Suppressed financial markets — strong state control over financial flows; credit allocated to productive sectors via state-controlled banks. NOT free-market finance

The African industrial-policy record

Failures: import-substitution industrialisation (1960s-80s)

Most African economies pursued import-substitution industrialisation (ISI) post-independence: protect domestic manufacturers from imports through high tariffs, subsidise their inputs, build state-owned firms to fill 'strategic' gaps. The record was disastrous:

• Protected firms became permanent rent-seekers — produced poor-quality products at high cost, never reached export competitiveness, retained tariff protection for decades
• Fiscal cost — subsidies and state-owned enterprises produced large deficits that ultimately required IMF programmes to resolve
• Resource misallocation — capital flowed to politically-connected sectors rather than productivity-justified ones
• Currency and balance-of-payments crises — overvalued currencies (required to keep imported inputs cheap for protected industries) caused export competitiveness erosion in non-protected sectors, leading to recurrent BoP crises

The Washington Consensus reforms of the late 1980s and 1990s (structural adjustment) targeted ISI directly — tariff cuts, subsidy elimination, SOE privatisation, financial liberalisation. The reforms reduced the worst rent-seeking but also dismantled the manufacturing base built under ISI, contributing to the premature-deindustrialisation pattern of the 1990s-2000s.

Mauritius: the African industrial-policy success

Mauritius is the standout. Post-independence (1968), the country pursued a deliberate export-oriented industrialisation strategy:

• Export Processing Zone (1971) — duty-free zones for export manufacturing (initially textiles and clothing). Tax holidays, free import of inputs, performance-based
• Sugar diversification — the EPZ moved Mauritius from sugar monoculture to a diversified export economy. Sugar fell from 90% of exports (1965) to <15% (2020)
• Tourism and offshore finance — sequential additions to the export portfolio. Offshore finance built on the Indo-Mauritian tax-treaty network (covered in Public Finance module 4)
• Education investment — primary universalisation, secondary expansion, technical training for textile and electronics sectors
• Macroeconomic stability — consistent low inflation, prudent fiscal management

Outcomes: Mauritius reached upper-middle-income status by the 2000s; HDI 0.80+; per-capita GDP ~$11,000. The single most successful African economic-policy programme of the post-independence era.

Ethiopia: the developmental state attempt

Ethiopia 2003-2018 pursued a self-consciously developmental-state model under the EPRDF government (Meles Zenawi). Heavy public investment in industrial parks, hydroelectric power (Grand Ethiopian Renaissance Dam), rail, road; targeted export-oriented manufacturing (textiles, leather, agro-processing); state-owned banks directed credit to selected sectors.

Outcomes were promising through 2018: 8-11% annual GDP growth; manufacturing exports doubling every 4-5 years; foreign direct investment from Asian apparel manufacturers (H&M, Calvin Klein supply chain) growing rapidly. Then the political crisis from 2018, the Tigray war (2020-2022), and macroeconomic instability undermined much of the gains. The model is contested — its proponents argue the political crisis is separable; its critics argue the political crisis was incubated by the very developmental-state model's exclusionary politics. Empirically unresolved.

The Hausmann-Rodrik 'self-discovery' framework

Hausmann and Rodrik (2003): the deep economic argument for industrial policy is that an economy doesn't automatically know what it can produce competitively. New sectors require entrepreneurs to invest in 'self-discovery' — finding out whether the country has comparative advantage in producing X. The first entrepreneur who successfully demonstrates the country can produce X creates a public good (information) but captures little of the value (imitators follow). Without a subsidy or other support, the first entrepreneur doesn't invest; without the first entrepreneur, the sector never emerges. This is a market failure with a specific economic logic — and it's the most defensible economic case for vertical industrial policy.

Modern instruments

• Special Economic Zones (SEZs) — geographically-defined zones with regulatory, tax, and infrastructure advantages. Mauritius EPZ; Ethiopian Hawassa Industrial Park; Kenyan Athi River EPZ and Naivasha SEZ. Performance is mixed — SEZs work when they have strong logistics, governance, and skills supply; fail when they're treated as pure tax-holiday vehicles
• Public-Private Partnerships (PPPs) for infrastructure — bringing private capital and management to infrastructure investments. Kenya's Lake Turkana wind power and other renewables; mixed record overall
• Performance-conditional tax incentives — investment-deduction allowances, R&D credits, employment-based credits. Conditional on hitting specific performance targets
• State-owned development banks — Kenya's Industrial Development Bank (rebooted as Kenya Development Corporation in 2020), Ethiopian Development Bank. Provide patient capital to productive sectors; their lending decisions and recovery rates determine whether they add value or destroy it
• Trade negotiations — AfCFTA, EAC, AGOA. Industrial policy operates partly through trade policy