The only significant policy initiative that the post-pandemic Indian economy has seen from the government has been an openness to use industrial policy as a tool for economic growth. This has anticipated opposition and outrage from economists who classify this “inside” view of the economy as a violation of the Washington Consensus, which advocates free trade, strong institutions, and a moderately indifferent government as the only cures for poverty and destitution. I recommend. less developed economies. India’s policy initiative, radical by historical standards, has been criticized on three main grounds. One, industrial policy has historically failed. Second, industrial policy failed because bureaucrats cannot allocate resources as well as markets can and therefore cannot. Choose “Winner”. And finally, for the above two reasons, industrial policy is essentially a “freebie” scheme that allows big industrialists/monopolies to extract rent from the state.
While these arguments are repeated time and again in every forum, little evidence is given to support them. Let us first look at the first claim that industrial policy has historically failed. This argument is supported by pointing to the rapid improvement in the standard of living of many countries (mostly Western) under free trade regimes. There are several flaws in this argument. The primary one is that for a less developed country to draw lessons from developed countries, one must look at the policies employed by developed countries when they were underdeveloped and not when they were already industrialized. Empirically all advanced economies have employed industrial policy aggressively and sometimes violently to achieve industrial status.
While this is true for all developed countries, in the interest of space, let us look at the case of the two bastions of free trade and capitalism, the UK and the US. No industrial policy tool is as hated and disdained by free trade economists as tariffs. Yet both the UK and the US were heavy users of tariffs to protect their infant industries when they were underdeveloped. In a brilliant book, “Kicking Away the Ladder”, Ha Joon Chang shows that the average import duty on goods manufactured in the UK was 55% by 1820 when the UK achieved worldwide technological and industrial dominance. A key feature of the UK Tariff Policy was to allow the duty-free import of raw materials, but impose heavy duties on finished goods to encourage value addition in Britain. Heavy restrictions were also imposed on manufactured imports from colonies such as India (Calico Act) and British goods were given duty-free access. Indian market in the spirit of “free trade” of the 18th century. The result was the complete destruction of the Indian textile industry, widely acknowledged at the time as the most sophisticated in the world, and the emergence of Manchester as a textile cluster, with 45% of British textile exports going to India. Various other non-tariff instruments were also used to promote domestic industry, such as the Navigation Act, which mandated that trade with Britain must be conducted on British ships.
Perhaps no other country in the world has used tariffs for industrialization like free land – the United States. In fact, industrial policy was so pervasive in America during the late 19th and early 20th centuries that economic historian Paul Barroch referred to America as “the mother country and bastion of protectionism”. Alexander Hamilton, one of America’s founding fathers and America’s first Secretary of the Treasury, wrote a brilliant treatise on industrial policy in general and tariffs as a tool of development in particular, and named it “Report on Manufacturing”. The US adhered to the treaty for most of its history and had tariffs of close to 50% on manufactured goods until the 1940s, when its industrial dominance became undeniable and it could promote “free trade”. In 1875, the US had a GDP per capita that was 3/4 that of the UK, then the richest country in the world, and yet had a 50% tariff. In comparison, when India joined the WTO, it had to reduce its tariffs by 32%, despite having a higher per capita income. A small part of America.
Another feature of American industrial policy was the theft of technology and weak copyright laws. Free trade economists have a habit of turning their knees at IPR violations by less developed countries like India. Yet the US (when it was relatively prosperous) did not accept foreign copyrights until 1891 and American “inventors” could have fun with foreign technology behind a protective tariff wall. These anecdotes do not even scratch the surface of the scale and scope of industrial policy. Which was employed by the developed countries when they were in a similar or even higher development position than India. Still, not taking into account the half a trillion industrial subsidies through the recently announced IRA and CHIPS Act, the US spends close to 1. % of its 23 trillion GDP on industrial policy In fact, an oft-repeated quip about US industrial policy is that America’s biggest industrial policy is to convince the world that it doesn’t have an industrial policy.
In short, contrary to free trade economists would have us believe, industrial policy is not back in fashion. This is because industrial policy has never been out of fashion. It was and will remain an integral part of the development strategy of any country. Doubts about its usefulness are quite misplaced as the world’s largest economies have used it and continue to use it aggressively. There are many examples of countries that have failed to develop without a coherent industrial policy (India), but there is no example of a country that has achieved advanced status without it. The standard strategy adopted by these advanced countries has been to use industrial policy to achieve technological dominance and then advocate free trade from a position of industrial hegemony to the detriment of less developed countries such as India.
While India is late to the game, a coherent industrial policy is vital to our ambitions. The second part of this article will explore in detail the strategic design of industrial policy and the characteristics/instruments of industrial policy that separate the spectacular success (Japan, Korea, Taiwan) from the pleasant average (Thailand, Malaysia) and the lessons for us from these cases .
Diva Jain is a Director at Arjavav and an ‘Observantist’ who researches and writes on behavioral finance and economics. Her Twitter handle is @DivaJain2.
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