Industrial policies and production networks

Oct. 5, 2018

The history of economic growth in Japan, South Korea, China and other ASEAN countries suggests that industrial policy can work. But how does a government choose which industries or sectors to target in a way that makes economic sense? Should governments focus on the industries that add most value to the economy, or on ones that suffer from the most imperfections, or weaknesses? New work by JRCPPF postdoctoral associate Ernest Liu provides sharp new insights into these questions. 

South Korea’s IO demand matrix, with HCI targeted sectors highlighted in dark
South Korea’s Input-Output demand matrix, with Heavy Chemical Industry (HCI) sectors highlighted in dark.

Liu’s paper presents a novel way of characterizing industries, not by size or imperfection, by the extent to which they serve as an input into the supply chains of other industries. Targeting industrial policies, such as subsidies or directed credit, towards the more upstream industries in a production network generally leads to more efficient economic outcomes. Applying the model to data, Liu measures the “upstreamness” of industries in South Korea and China, and demonstrates that these countries subsidized exactly the set of industries that theory predicts they should have.

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