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Protectionism can work, but design is crucial. Protectionism is a thorny policy issue, with many pitfalls that may actually contribute to the crippling of domestic industries. For example, we found evidence that import protection may be a viable tool for industry promotion, assuming that there is no retaliation from trading partners. This assumption is, however, highly unlikely to hold true in today’s international economic reality, as such measures will necessarily be in conflict with foreign interests. Even then, the evidence seems to suggest that protection needs to be focused on consumption goods, rather than intermediate input goods. Further, a distinction needs to be made between homogeneous and differentiated goods, indicating that there is greater potential in developing niche industries in differentiated goods.
Two major findings necessitate the complementary consideration of the next two best practices, namely that successfully industrializing countries have complemented protection with active domestic industry support and that governments have historically been unable to design adequate sectoral protection patterns.
Industry support should be provided in a transparent way that maintains competition and is incentive compatible. As all forms of industry support are fraught with the threat of capture by special interest, steps must be taken to ensure transparent selection criteria. Not only is picking winners inherently difficult for governments, who have less knowledge of firmspecific characteristics than, for example, managers, it also encourages wasteful use of resources by incumbents and discourages entry by more innovative new firms. Hence, industry support should not discriminate among firms within the promoted industry. In this context, the ability of governments to withdraw support in case of underperformance is equally important. Sunset clauses that link government support to performance criteria have been instrumental in ensuring incentive compatibility of government aid to industry in successfully industrializing Asian countries. Basing such performance criteria on export data has the double advantage of ensuring that firms are exposed to the dynamics of the international market and providing a reliable indicator of industry success.
Temporary support for “sunset” industries may be a necessary step to make a broader structural reform package politically feasible and to ease the transition for affected workers. In such cases, the temporary aspect of the support scheme needs to be communicated clearly, and complementary policies should encourage the retraining of workers to acquire the new skill sets required for an emerging industry.
IISD REPORT JUNE 2013 2013 The International Institute for Sustainable Development © Industrial Policy for a Green Economy The evidence concerning FDI is particularly clear on the need for well-defined policy objectives. Attracting FDI in downstream sectors appears to stimulate upstream domestic industry, whereas active policies are needed to ensure horizontal spillovers for domestic industries operating in the same sector. Here, the challenge is to achieve an adequate balance between offering an attractive investment framework for foreign investors and setting the right incentives for technology and knowledge transfers. While local content requirements, subcontracting and joint ventures have been used extensively in China, it remains unclear whether countries with smaller markets can impose such regulation on multinationals without affecting their investment decisions. In any case, the literature agrees on the importance of fostering a country’s absorptive capacity as a key determinant for technology transfer, necessitating, for example, active policies to develop an aptly skilled domestic workforce.
Close collaboration between governments and industry can optimize information flow. In order to design adequate support schemes, policy-makers need to have extensive knowledge about which market failures need to be addressed.
Answering this question involves identifying industries with potential for positive spillovers, inter-industry and inputoutput linkages, perceived bottlenecks to coordination of investments, the nature of financial constraints and credit market imperfections. A defining feature of successful industrial policy has thus been regular knowledge exchange between high-level government and industry representatives to ensure the continued relevance and effectiveness of industrial support. This process implies clear objective setting, monitoring, progress and impact evaluations, as well as capacity building for government bureaucrats. Given the complexity of the domestic economic tissue and its countless connections to the outside world, for example through global value chains, industrial policy making necessarily operates under high levels of uncertainty and will often be trial and error.
Strengthening government capacity can help avoid government failure. Government capacity to correctly anticipate trends and effectively withdraw support once it is no longer necessary calls for a highly competent bureaucracy with highly skilled people taking key roles, and accordingly competitive pay, which also helps insulate officials from corruption.
Targets of industrial policy are country-specific. Economists have long argued for countries to upgrade their industrial structure according to their comparative advantage. However, a few successful countries have demonstrated that industrial policies may contribute to a substantial shift in what those countries are best at producing. While there is still considerable disagreement on which sectors offer the greatest return on industrial policy, a number of recent research offers avenues of identifying these, though some of those avenues compete. While government policy should certainly be informed by these studies, it should also be clear that there is currently no blueprint that fits across all countries.
Hence picking winning sectors should be the result of careful examination of both the literature and strategies identified through country-specific government-industry collaboration.
IISD REPORT JUNE 2013 2013 The International Institute for Sustainable Development © Industrial Policy for a Green Economy
4.0 Green Industrial Policy Our analysis has up to now focused on what may be called the conventional economic paradigm, which is largely confined to the purely economic realm and makes few explicit efforts to integrate external social or environmental considerations.
In the absence of market failures, supply and demand are efficiently balanced through price signals. And while there has been steadily increasing demand for finite resources such as water, energy (mostly fossil-based) and various materials, a combination of technological improvements and the discovery of new, low-cost sources of supply has been able to sustain economic growth while keeping resource prices flat throughout the last century (Dobbs et al., 2011). Nevertheless, resource prices have soared in the last decade, reaching record levels in recent years.
FIGURE 7. COMMODITY PRICES HAVE INCREASED SHARPLY SINCE 2000Data source: GEM Commodities, World Bank Group.
The extraordinary rise of commodity prices has been accompanied by heightened price volatility, significantly impacting investment decisions by adding uncertainty over future developments. This trend can be attributed to a number of developments, none of which is likely to subside in the near future. Rapidly rising global population and phenomenal growth in emerging economies are stimulating global demand at an unprecedented scale. Technological innovation cannot keep up with the speed of increase of consumption in emerging markets, that is, the first mechanism for keeping resource prices at bay during the 20th century is currently impaired. At the same time, the second mechanism is not working either, effectively magnifying the price effect of the former. With a given amount of resources, unabated extraction cannot go on forever. Increasing scarcity requires increasingly intrusive and hence costly extraction methods to discover new sources of resource supply. Therefore, supply lags behind demand and cannot easily adjust to shifts, such as during recessions, and this increases prices and their volatility.
IISD REPORT JUNE 2013 2013 The International Institute for Sustainable Development © Industrial Policy for a Green Economy More fundamentally, resource prices rarely reflect their true economic value. In a purely market-driven economy, this is due to the presence of substantial market failures due to the inability of private actors to internalize environmental externalities, as described in chapter 1. The negligence of the conventional economic paradigm to account for these has resulted in price signals that have encouraged irresponsible resource management that allows excessive use of resources. Resource depletion and degradation of ecosystems are threatening the very foundation of the economy and are often irreversible. The absence of a carbon price has resulted in human-induced climatic change, whose catastrophic effects are increasingly being felt throughout the world.
NatCatSERVICE Natural catastrophes worldwide 1980 – 2012 Number of events
© 2013 Münchener Rückversicherungs-Gesellschaft, Geo Risks Research, NatCatSERVICE – As at January 2013 FIGURE 8. NUMBER OF CATASTROPHES WORLDWIDE, 1980 TO 2012 The number of disruptive natural events has risen over the past three decades. Reprinted with permission from Munich RE (2013).
Apart from market failures, government policies have contributed to the misalignment of prices with their true value, setting the wrong incentives. Subsidies for agriculture, water consumption and fossil fuels have been pervasive throughout the second half of the last century and are currently estimated at a global level of up to US$1.1 trillion annually (Dobbs et al., 2011).
With this background, it is not surprising that calls for a paradigm shift have gained considerable momentum in recent years. The “green economy” is at the centre of this new public debate. While there is no universally agreed definition of what the term really involves, there appears to be consensus on the need for a green economy to be consistent with the earlier notion of sustainable development, reflecting a holistic approach to development that strives for intergenerational IISD REPORT JUNE 2013 2013 The International Institute for Sustainable Development © Industrial Policy for a Green Economy justice in terms of economic, social and environmental well-being. The United Nations Environment Programme defines a green economy as “one that results in improved human well-being and social equity, while significantly reducing environmental risks and ecological scarcities.” The fact that economic growth, even measured imperfectly by GDP, has historically been associated with rising economic and social well-being has led to the emergence of the term green growth, which “is about making growth processes resource-efficient, cleaner and more resilient without necessarily slowing them” (Hallegatte, Heal, Fay & Treguer, 2012, p. 2). An exceptional amount of research within the last few years has offered substantial grounds to believe that “green growth” is indeed not an oxymoron, and that there are important synergies to be exploited.6 And the proven failure of markets alone to take advantage of such synergies calls for increased government effort to provide a policy framework that is conducive to optimized market behavior.
Therefore, pursuing green growth is in principle consistent with the use of traditional industrial policies for development, when motivated by considerations laid out in our previous analysis, and subject to the same limitations. But green growth requires the emergence and strengthening of green industries in order to harness synergies in terms of economic, social and environmental benefits. This adds yet another layer of complexity to industrial policy, warranting the use of the distinctive term green industrial policy.
The following section will briefly review the concept of green industries with an eye toward rationalizing the use of supporting policies.
Green Industries It is analytically convenient to distinguish between the greening of (existing) industries and the stimulation and creation of green industries, as suggested by UNIDO (2011). However, we will see that in fact the two overlap and interact a great deal, as exemplified by the renewable energy sector, which we will briefly highlight as well.
The Greening of Industry The greening of industry refers to the constant improvement of environmental performance of all industry, regardless of sector, size or location.
Most obviously, the greening of industries can be pursued through promoting greater resource efficiency. Resource inputs are a cost to industry and can account for up to 65 per cent of costs in the food and beverage sectors and 70 to 80 per cent in the steel sector (Manyika et al., 2012). Energy costs alone can make up 30 per cent of total value added in industries such as basic metals, paper and pulp, mineral products, rubber and plastics, and chemicals (Manyika et al., 2012). Such economic considerations have already contributed to increased resource efficiency over the last decades, as evidenced in declining material intensity.
An overview of these publications by major international organizations can be found at http://www.greengrowthknowledge.org/Pages/ Reports.aspx.
IISD REPORT JUNE 2013 2013 The International Institute for Sustainable Development © Industrial Policy for a Green Economy