Introduction
Industrial policies – strategic interventions designed to reshape an economy’s production structure – have experienced a remarkable global resurgence. These policies can be effective and justified when addressing clear and pressing market failures, such as climate change and environmental degradation. However, their overall track record is mixed, particularly when considering their actual benefits, the costs incurred and the consequences of missteps.
Foreword
I Industrial policies – strategic interventions designed to reshape an economy’s production structure – have experienced a remarkable global resurgence. These policies can be effective and justified when addressing clear and pressing market failures, such as climate change and environmental degradation. However, their overall track record is mixed, particularly when considering their actual benefits, the costs incurred and the consequences of missteps.
Indeed, with every market failure that they seek to correct, there is a looming risk of government failure. With 80 to 90 per cent of industrial policies discriminating against foreign interests, such measures can undermine the level playing field and place strains on multilateral cooperation. There is also a risk that industrial policies may be viewed as a “quick fix”, diverting attention away from necessary – but more demanding – tasks such as improving the business environment, enhancing infrastructure and raising skill levels.
Yet voters in the EBRD regions and beyond are increasingly expressing a preference for government intervention, large states and subsidies. And active pursuit of industrial policies by large economies – often to the detriment of their trading partners – is compelling more and more governments to embark on similar endeavours. Thus, domestic political economy considerations, geopolitical tensions and the actions of others are steering policymakers away from optimal economic solutions and international cooperation.
As a result, industrial policies are increasingly being rolled out in economies with lower levels of income per capita, less fiscal space and weaker institutions. As this report shows, those economies tend to use less costly but much more distortionary instruments to achieve their policy objectives, such as export bans and quotas, or licensing requirements for exports and imports. When implemented poorly, these have the potential to cause a misallocation of labour and capital, increase costs for local producers and breed corruption.
This report provides a rich characterisation of industrial policies in the EBRD regions and beyond using several novel datasets. It offers several principles that can increase the chances of success and reduce the chances of failure when pursuing industrial policies. In most cases, though, the conclusions of our analysis are somewhat nuanced. For instance, investment promotion policies can be effective in attracting foreign investment in targeted sectors – but only in economies with sufficient state capacity. Where state capacity is low, such policies are costly but yield no significant benefits. Similarly, tax incentives can be a good means of developing knowledge-intensive service sectors – but only in regions where the right human capital is available. Elsewhere, the returns may not be sufficient to compensate for the tax revenue that has been forgone. Moreover, special economic zones often have some positive impact on economic activity at a local level – but this impact is conditional on a variety of local circumstances, including the skill base of the local population and proximity to key physical infrastructure such as ports.
Applying the various principles that increase the chances of an industrial policy being a success is easier said than done, judging by the landscape of industrial policies that is surveyed in this report. Clearly articulating the goals of each policy – at least privately, and preferably publicly – and establishing a hierarchy of objectives is key. However, most policies combine two or three different objectives, and those goals often clash with each other. For example, the objective of speeding up the transition to a green economy often runs counter to the objective of protecting domestic employment or the desire to control the supply chain owing to security considerations. Consequently, a lack of coordination and a clear hierarchy of objectives can mean that a country’s industrial policies cancel each other out or pile distortions upon distortions. Lastly, there is scope to make industrial policies – especially state assistance for firms – much more targeted by tailoring them more explicitly to targeted firms’ age, growth potential and capacity to innovate.
In conclusion, industrial policies have the potential to deliver results, but making this happen is hard enough in the economies with the strongest institutions. If emerging market economies want to scale up the use of industrial policies, they will have to learn fast with little room for mistakes. The costs of failure – increased government spending, economic distortions and forgone revenue – can pile up quickly in the balance sheets of overburdened governments.
Beata Javorcik
EBRD Chief Economist
Highlights
CHAPTER 1
An introduction to industrial policy
Industrial policies have seen a resurgence recently, seeking to address market failures such as environmental degradation. Their track record is mixed at best, with their growing popularity shaped primarily by domestic political economy considerations and geopolitical tensions. While industrial policies are typically employed by higher-income economies, they are also becoming more common in economies with less administrative and fiscal capacity to implement them.
CHAPTER 2
Promoting structural change
Before 1990, many developing economies had growth models that prioritised industrialisation, supported by investment in capital equipment, training and infrastructure. Over time, however, the pursuit of manufacturing export-led growth has become increasingly challenging.
CHAPTER 3
Regional inequality and special economic zones
Place-based industrial policies are strategic interventions aimed at promoting economic development in specific geographical areas – typically those that are underdeveloped or have specific endowments of natural resources or skills. One such policy, the establishment of SEZs, has become increasingly popular as a way of attracting foreign investment, boosting growth and exports, and addressing persistent regional income inequalities.
CHAPTER 4
Industrial policies supporting firms
In the EBRD regions, a relatively small number of large firms – those with 100 employees or more – account for the majority of employment as a result of their economies of scale, higher levels of productivity and greater propensity to innovate. Meanwhile, the largest listed firms account for a sizeable and rapidly growing share of economies’ total output and exports (a trend that can also be observed in other emerging markets), with private-sector firms accounting for most of the recent increases in the total revenue of the largest firms. Among small and medium-sized enterprises, young firms – those that are five years old or less – tend to enjoy stronger employment growth and higher returns to capital.
CHAPTER 5
Structural reform
This final chapter presents updated transition scores for EBRD economies, tracking progress in the area of structural reform. It focuses on six key qualities of a sustainable market economy, looking at whether economies are competitive, well governed, green, inclusive, resilient and integrated.
Highlights
CHAPTER 1
An introduction to industrial policy
Industrial policies have seen a resurgence recently, seeking to address market failures such as environmental degradation. Their track record is mixed at best, with their growing popularity shaped primarily by domestic political economy considerations and geopolitical tensions. While industrial policies are typically employed by higher-income economies, they are also becoming more common in economies with less administrative and fiscal capacity to implement them.
Increasingly, industrial policies target multiple objectives, with no clear prioritisation. While such policies have traditionally targeted economic growth and productivity, green objectives are gaining prominence, particularly in advanced economies – often in combination with a strategic goal of ensuring a secure supply of critical materials and technology. Regional development objectives have also become more important, particularly in EBRD economies. Against that background, policymakers need to articulate (ideally publicly or at least privately) the dominant objective of each policy and establish evaluation mechanisms to determine whether a policy will achieve its aims or should be modified or abandoned.
While industrial policies can overcome coordination failures and promote the creation and transfer of knowledge, they can entail high explicit fiscal costs and cause significant implicit costs by distorting the efficient allocation of labour and capital. The risk of capture by special interests is also high. Less-distortive policy instruments typically require greater administrative capacity and more revenue-raising ability.
To minimise distortion, policies can incorporate competitive selection and specific end dates. While the percentage of policies with sunset clauses has risen, firm-specific policies and measures discriminating against foreign firms are common, and use of subsidies has increased. Where administrative capacity is low, policymakers could phase in policies, prioritise projects falling within the remit of a single ministry and establish specialist units to oversee initiatives.
CHAPTER 2
Promoting structural change
Before 1990, many developing economies had growth models that prioritised industrialisation, supported by investment in capital equipment, training and infrastructure. Over time, however, the pursuit of manufacturing export-led growth has become increasingly challenging.
At the same time, the advent of digital technologies has transformed services, facilitating cross border trade, and manufacturing has become increasingly reliant on service inputs. Within services, digitally enabled, tradable services – especially global innovator services such as information and communication technology (ICT) services – exhibit particular growth potential. These have increasingly driven improvements in the labour productivity of the service sector. Such services require high skill levels, can be traded across borders and have strong linkages to other economic sectors.
While many post-communist EBRD economies are top exporters of computer and information services, others need to upgrade their infrastructure, skills and institutional capabilities in today’s service-based world.
Service trade liberalisation and targeted industrial policies can support shifts towards high value added services, provided that the necessary fundamentals are in place. For instance, economies with strong state capacity see marked increases in service-related foreign direct investment after investment promotion agencies start to target foreign investment in specific service sectors. No such effects are observed when state capacity is weaker, however. Similarly, tax incentives granted to computer and information service firms in Romania have succeeded in supporting employment growth in that sector, but primarily in regions with strong endowments of specialist human capital.
Service trade liberalisation is also associated with increases in the competitiveness of manufacturing sectors. However, lowering restrictions on trade does not necessarily mean having a regime where anything goes. For example, legislation equivalent to the EU’s General Data Protection Regulation has been found to facilitate trade in services by establishing fair and transparent rules on data.
CHAPTER 3
Regional inequality and special economic zones
Place-based industrial policies are strategic interventions aimed at promoting economic development in specific geographical areas – typically those that are underdeveloped or have specific endowments of natural resources or skills. One such policy, the establishment of SEZs, has become increasingly popular as a way of attracting foreign investment, boosting growth and exports, and addressing persistent regional income inequalities.
Such regional inequalities can be seen in both official data and night-time light data, with large – and growing – differences between rural and urban areas as regards economic opportunities. Coastal regions and areas bordering higher-income economies also tend to be richer. Analysis reveals that the average annual rate of intra-country convergence across the EBRD regions was approximately 1 per cent over the period 2010-19. At that rate, it will take about 70 years to halve the existing regional income gaps within EBRD economies.
The number of SEZs in EBRD economies has risen from less than 200 in 1990 to more than 1,100 in 2020, mirroring global trends. While some SEZs are in lower-income regions, others are in richer areas. SEZs in higher income regions tend to be larger and may leverage existing endowments of natural resources or skills.
Analysis of night-time lights suggests that establishing an SEZ is associated with increased economic activity over time within an immediate radius of up to 20 km. Economic outcomes tend to be better when SEZs benefit from a strong skill base, proximity to a port and robust local governance. Analysis also reveals that firms situated near technology development zones in Türkiye have seen stronger increases in employment, exports, investment, sales, profits and total factor productivity. Overall, however, the success of an individual SEZ appears to be very difficult to explain after the fact, let alone predict in advance.
CHAPTER 4
Industrial policies supporting firms
In the EBRD regions, a relatively small number of large firms – those with 100 employees or more – account for the majority of employment as a result of their economies of scale, higher levels of productivity and greater propensity to innovate. Meanwhile, the largest listed firms account for a sizeable and rapidly growing share of economies’ total output and exports (a trend that can also be observed in other emerging markets), with private-sector firms accounting for most of the recent increases in the total revenue of the largest firms. Among small and medium-sized enterprises, young firms – those that are five years old or less – tend to enjoy stronger employment growth and higher returns to capital.
Direct state assistance for firms is increasing in EBRD economies, although such policies remain less prevalent, on average, than in advanced European economies. The most common forms of direct state assistance in EBRD economies are financial grants and state loans, with other forms of assistance including in-kind grants, production subsidies, loan guarantees, interest payment subsidies, tax relief of various kinds and equity capital injections.
Direct support for firms – including young firms – can be highly effective, as illustrated by the EBRD’s Star Venture programme, which targets startups under the age of 10, providing tailored advisory services, training and mentorship. Participation in that programme results in firms securing more funding, employing more people and having more followers on LinkedIn relative to other firms that are shortlisted for participation but ultimately rejected.
At the same time, most direct state assistance policies do not target particular types of firm (such as young or small firms). Tailoring such policies to targeted firms’ age, growth potential and innovation potential is crucial in order to maximise their benefits relative to their costs.
CHAPTER 5
Structural reform
This final chapter presents updated transition scores for EBRD economies, tracking progress in the area of structural reform. It focuses on six key qualities of a sustainable market economy, looking at whether economies are competitive, well governed, green, inclusive, resilient and integrated.
This year, for the first time, the analysis in this chapter also covers six comparator economies in sub-Saharan Africa (SSA): Benin, Côte d’Ivoire, Ghana, Kenya, Nigeria and Senegal. Their scores tend, overall, to be lower than those of EBRD economies, broadly in line with their lower income per capita at market exchange rates. The largest gap between the SSA region and EBRD economies is in the area of integration, reflecting scarce infrastructure and low levels of intra-regional trade and investment in sub-Saharan Africa. Indeed, the SSA region stands out for its low levels of cross border trade and the scarcity of transport and fixed-line broadband infrastructure, even when its modest levels of income per capita are taken into account. There is also a large gap in the area of competitiveness, reflecting low levels of productivity and skills in SSA economies.
Meanwhile, the average inclusion score for SSA economies is, if anything, slightly higher than the average for Central Asia and the southern and eastern Mediterranean – EBRD economies with fairly low levels of income per capita. This reflects the relatively high male and female labour force participation rates in SSA economies.
In the period since 2016, EBRD economies’ scores for integration and the green economy have increased the most overall, with competitiveness, inclusion and governance scores improving the least. In SSA economies, meanwhile, scores for competitiveness and resilience have improved the most, with little progress being observed in the area of integration.
EVENTS
WHERE WE WORK
The EBRD is investing in changing people’s lives and environments across a region that stretches from central Europe to Central Asia, the Western Balkans and the southern and eastern Mediterranean.