The government takes measures "aimed at improving the competitiveness and capabilities of domestic firms and promoting structural transformation." A country's infrastructure (transportation, telecommunications and energy industry) is a major part of the manufacturing sector that often has a key role in IP.
Industrial policies are sector-specific, unlike broader macroeconomic policies. Examples of the latter, which are horizontal, economy-wide policies, are tightening credit and taxing capital gains. Traditional examples of industrial policy that involves vertical, sector-specific policies, include protecting textiles from imports and subsidizing export industries. More contemporary industrial policies include measures such as support for linkages between firms and support for upstream technologies.Industrial policies are interventionist measures typical of mixed economy countries.
Many types of industrial policies contain common elements with other types of interventionist practices such as trade policy and fiscal policy. An example of a typical industrial policy is import-substitution-industrialization (ISI), where trade barriers are temporarily imposed on some key sectors, such as manufacturing.
By selectively protecting certain industries, these industries are given time to learn (learning by doing) and upgrade. Once competitive enough, these restrictions are lifted to expose the selected industries to the international market.
Criticism
The main criticism against industrial policy arises from the concept of government failure. Industrial policy is seen as harmful as governments lack the required information, capabilities and incentives to successfully determine whether the benefits of promoting certain sectors above others exceeds the costs and in turn implement the policies.While the East Asian Tigers provided successful examples of heterodox interventions and protectionist industrial policies, industrial policies such as import-substitution-industrialization (ISI) has failed in many other regions such as Latin America and Sub-Saharan Africa. Governments, in making decisions with regard to electoral or personal incentives, can be captured by vested interests, leading to industrial policy only supporting the rent-seeking political elite while distorting the efficient allocation of resources by market forces at the same time.
Debates on the 'how to' of industrial policy
Despite existing criticism, there is a growing consensus in recent development theory that state interventions are often necessary when market failures prevail. Market failures often exist in presence of externalities and natural monopolies. These market failures hinder the emergence of a well-functioning market and corrective industrial policies are required to ensure the allocative efficiency of a free market. Even relatively sceptical economists now recognise that public action can boost certain development factors "beyond what market forces on their own would generate. In practice, these interventions are often aimed at regulating networks, public infrastructure, R&D or correcting information asymmetries. While the current debate has shifted away from dismissing industrial policies overall, the best ways of promoting industrial policy are still widely debated.One key question is which kinds of industrial policy are most effective in promoting economic development. For example, economists debate whether developing countries should focus on their comparative advantage by promoting mostly resource- and labour-intensive products and services, or invest in higher-productivity industries, which may only become competitive in the longer term.
Much debate also still surrounds the issue whether government failures are more pervasive and severe than market failures. Some argue that the lower the government accountability and capabilities, the higher the risk of political capture of industrial policies, which may be economically more harmful than existing market failures.
Of particular relevance for developing countries are the conditions under which industrial policies may also contribute to poverty reduction, such as a focus on specific industries or the promotion of linkages between larger companies and smaller local enterprises.
