Both the state and market have a role to play in successful tech and innovation policies, and we can all benefit from the opportunities created

Whether in the US or China, state-led industrial strategies have played a key role in economic growth and development. Today, industrial policy is back on the agenda in many countries, after decades on the fringes

Reda CherifandFuad Hasanov

Published: 1:00am, 1 Nov, 2019

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In the January 1954 issue of The Atlantic, John F. Kennedy, then the junior US senator from Massachusetts, argued that the ongoing migration of industries from New England to the American South should not be hindered. He called on the government instead to provide loans and other forms of support to assist New England-based businesses, retrain industrial workers and fund local industrial development agencies.

Kennedy recognised that the government had an important role to play in both lifting the South and spurring new industries in New England.

Today, industrial policy is back on the agenda, after having spent decades on the fringes of the policy debate. In addition to China’s “Made in China 2025” initiative, Britain’s recently released Industrial Strategy, and a new Franco-German policy manifesto, Gulf Cooperation Council countries have also adopted strategies to develop non-oil sectors, and many developing countries are pursuing similar diversification efforts.

These policies have emerged as a response to pressures from international competition, a broad slowdown in productivity growth, manufacturing job losses and rising inequality. But industrial policy has always stirred an intense debate among policymakers and academics.

Critics argue that such strategies have not worked in many countries, and have instead resulted in cronyism and corruption. A better approach, they argue, is to reduce the role of the state in the economy, improve the business environment, and invest in infrastructure and education. Under favourable conditions, firms and entrepreneurs will emerge and grow in multitudes. The real-world failures of industrial policies in Latin America and elsewhere attest to the validity of this view.

In contrast, proponents of industrial policy argue that we live in a world of market failures that require some sort of state intervention. Otherwise, new sectors, especially advanced technology sectors, simply would not emerge, even in a good business environment. Naturally, this camp focuses on past successes, particularly in East Asian economies.

In a recent International Monetary Fund working paper, we used these past successes to identify three principles that underlie what we call a “true” industrial policy.

In the Asian “miracle” economies – such as Singapore and South Korea – as well as in Japan, Germany and the United States, the government intervened early on to support domestic firms in emerging, technologically sophisticated sectors.

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The successful policies placed special emphasis on export orientation, and held firms accountable for the support received. Given the strong focus on cutting-edge sectors, this “true” industrial policy is essentially a technology and innovation policy.

Technology and innovation are key to economic growth. China’s Made in China 2025 programme essentially emulates the strategy used by South Korea (and Japan before it) to escape the so-called middle-income trap. Likewise, the new British and Franco-German industrial strategies focus on the industries of the future: renewable energy, artificial intelligence and robotics.

Capitalising on the potential of disruptive innovation is an option for advanced and developing countries alike. Regardless of one’s place in the global value chain, producing cutting-edge technologies creates opportunities not only for domestic investors and businesses but also for consumers and industries elsewhere.

Moreover, technological advances in the US, China, Britain, France, Germany and other countries could be beneficial to all, contributing to competition, innovation and living standards globally.

Just as it takes two wings to fly, both the state and the market are needed to implement an effective technology and innovation policy. Indeed, “state vs market” is precisely the wrong way to think about it. As we argued in our 2016 book, Breaking the Oil Spell, the state must take the lead in steering resources towards activities that the market might not initially support on its own.

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At the same time, governments must also adhere to decision-making processes based on market signals, in order to guarantee space for an autonomous, competitive private sector. As economist Mariana Mazzucato argues, “when the public takes the lead and is ambitious, not just facilitating or being meek, it can push the frontier”.

As Mazzucato explains in The Entrepreneurial State, back when the US was dealing with the disappearance of New England’s old industries, it was also promoting technological innovation and spurring the creation of new sectors through public investment in research and development, as well as through government procurement policies.

Indeed, in 1979, US federal government procurement accounted for over half of total purchases of aircraft, radio and TV equipment.

More broadly, there are many theoretical and empirical reasons for the state to support the maturation and commercialisation of new technologies through public R&D, provision of risk capital, and investments in infrastructure and skills. Such outlays not only benefit existing innovation hubs, but also help to create new ones.

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The impact of state-led development is best illustrated by Kennedy’s call in 1961 for a moon shot: a seemingly impossible task became a reality by the end of the decade.

America’s drive to support technology and innovation has led to path-breaking advances in science and disruptive technologies, and to the birth of the world’s leading hi-tech industries. Following in its footsteps, many Asian economies have achieved economic miracles of their own by pursuing a “true” industrial policy.

Now, all countries have a chance to find a niche in which to implement a technology and innovation policy. If they succeed, the knowledge spillovers will benefit us all.

Reda Cherif is a senior economist at the International Monetary Fund. Fuad Hasanov is a senior economist at the International Monetary Fund and adjunct professor of economics at Georgetown University. Copyright: Project Syndicate

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