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Tuesday February 27, 2024

Towards industrial policy 2.0: Part - III

May 26, 2023

Instead of choosing the winners and losers which was the case with the industrial policy 1.0, the thrust of the new policy that is still evolving is to align the pattern of production to meet the future requirement of the economy, integrate in the global value chains, invest in research and development of technologies that give an edge and spurt to the economy, and invest in human capital formation throughout the lifecycle right from early childhood development to social protection.

Academic literature and experience of successful countries in East Asia, China and Vietnam no longer consider the state and market as a binary but as self-reinforcing and complementing each other. A capable and effective government with competitive and well-functioning markets will produce optimum results. Governments should invest in research and development, a skilled and trained labour force, and develop symbiotic public private collaboration, digital infrastructure and core data capabilities.

The private sector should be engaged in production, distribution and exchange of goods and services, pay their due taxes and curb anti-competitive practices such as collusion, cartelization and contrivance. The 2019 pandemic showed that business and government can’t be really disentangled; they rely on each other more than the partisans care to acknowledge. The Pfizer vaccine is based on insights into chemistry and molecular biology developed in government and university labs over a long period of time. State-funded basic research enforced patents and safety regulations, and industries turned raw ideas into a marketable product.

In recent years, a perceptible change in attitudes has been observed. The forceful advocates of globalization – the US and other Western powers – who used to preach quite forcefully to developing countries to open up their economies have gone into retreat. The main champion of globalization at the World Economic Forum a few years ago was none other than President Xi Jinping whose country has tasted the elixir of globalization. US President Trump was conspicuous by his absence at the forum that year.

The US has assumed the leadership role in steering a new type of industrial policy. President Trump’s campaign was based on the premise that as a result of globalization, American people had become sharply divided into two distinct groups – the well-off highly educated people living in thriving places and the less educated who lived in places that were left behind.

Trump concluded that liberal trade and free flow of capital and technology, outsourcing of manufacturing facilities and tradable services to other countries, and absorption of a large number of migrants had made the lives of this latter group miserable. They lost their jobs but were not trained to take up alternate occupations. He therefore introduced tariff and non-tariff barriers to thwart the inroads of Chinese goods and services in the US. His migration policy was quite tough and technology transfer from and to the US was firmly controlled.

US President Biden has gone even further and given more impetus to the industrial policy for the US. The CHIPS and Science Act 2022 gives the government a primary role in deciding which chip makers will benefit from the funding of $52 billion worth of subsidies and tax credits for manufacturing firms setting up new or expanding existing operations in the US. The Act has also allocated $200 billion towards scientific research in AI, robotics and quantum computing.

The infrastructure bill has tougher ‘Buy American’ rules, provision for reindustrialization, big innovations in technologies competing with China. The Foreign Direct Product Rule has also tightened export controls on technology transfer to China. Russia was cut off from the US technology supply chain globally.

Under the Inflation Reduction Act, an amount of $400 billion would be allocated as subsidies to adopt green technologies, to boost clean energy and reduce dependence on China for batteries for electric vehicles.

Sixty-three per cent of investment flows in the US are subject to the screening regime – up from 52 per cent in 2020. Sixty per cent of the value of stock markets fall under the potential review of the Committee on Foreign Investment in the US (CFIUS). US capital is not allowed to enhance the technological capabilities of the competitors.

The European Union (EU) is far ahead of other countries in pursuing an active industrial policy. Germany plans to subsidize power to industries up to 80 per cent. EU farm subsidies amount to $65 billion annually in addition to hefty budgetary grants to backward regions in the member countries. Governments help companies invest in green technologies and cut reliance on dominant suppliers and boost industry. They have also signed on to long-term contracts with the firms within the EU for supply of crucial raw materials such as lithium, rare earths and also fixed targets for domestic industries for domestic production of strategic technologies.

According to policymakers, climate change, disruptions during Covid-19, Russia’s invasion of Ukraine underline the need for a more interventionist state. Subsidies among the G7 countries have risen sharply from 0.6 per cent of GDP in 2016 to 2.0 per cent in 2020. Some proponents of the new industrial policy have justified the competition between the US and the EU as a valid tool for combating the risks of climate change which is an existential threat.

These subsidies and interventions are, unlike the past, not aimed at accelerating economic growth but protecting the future generations from calamities, disasters and disappearance. However, export controls, screening of foreign investment, ban on transfer of technology to competing nations and relocation of some industries within national jurisdictions in the name of avoiding supply disruptions do smack of old protectionist tendencies.

According to the UN, more than 100 countries accounting for over 90 per cent of the world’s GDP have adopted formal industrial strategies. Around $371 billion has been earmarked by seven countries for the semiconductor industry. Clean energy and batteries would cost 3.2-4.8 per cent of global GDP.

India is offering $26 billion of production-linked incentives for promoting electronics, semiconductors, electric vehicles, and mobile phone manufacturing over the next five years.

An IMF paper in 2022 justified the industrial policy by the presence of sector-specific externalities where the benefits of addressing them outweigh the costs and risks of the proposed intervention. Coordination failures and learning externalities imply that firms do not fully internalize the gain from potential activities. The emergence of new modern sectors hinges on the presence of effective government institutions, a favourable business environment and investment climate, and credible macroeconomic policies. Policy failures may include a burdensome regulatory framework, high tariffs on critical inputs, an overvalued exchange rate, inadequate infrastructure or an insufficiently skilled workforce.

Whether Pakistan should pursue an industrial policy or not is a question that has not yet been debated seriously. There are clear ideological divisions between those who believe that the state should have a better control over the generation and allocation of resources and others who are of the view that the state should set the direction and incentives structure and let households, private firms, businesses and farmers make the choices.

The important questions that need to be addressed are: (a)what is the end goal of such a policy; (b)what would be the nature of policy interventions by the state; and (c) what would be the main ingredients of the policy which should be used to achieve the end goal?

To be continued

The writer is the author of 'Governing the ungovernable'.