Revisiting Industrial Policy in Latin America

In early September, I participated in a mission to Peru to discuss the government’s National Plan of Productive Diversification. Over the last few decades Peru achieved macroeconomic stability and, relative to the region, considerably improved a number of economic indicators. However, Peru’s exports are still highly concentrated in the mining sector, and thus, as a small open economy, the country is highly vulnerable to the behavior of world markets. In order to overcome this problem, the Peruvian government has decided to pursue active policy that will lead to the diversification of the economy into new competitive sectors with high growth potential and significant global demand.

This is not precisely music to the ears of many. It brings back bitter memories of previous attempts in the region to pursue industrial policies by heavily subsidizing or imposing high tariffs on “hand-picked” sectors. This led to undesirable rent seeking behavior and, quite frankly, not a great deal of diversification. So, why is this again on the agenda for some countries?

Revisiting the industrial policy “taboo” can, however, lead to a healthy discussion. Most of the debate in academic circles is on whether industrial policy, as a whole, is justifiable or not. However, the proper debate should focus on how to design these policies so that they can fix the prevalent market failures where a fix is possible. No effective policy can be designed without a clear identification of the market failure, regardless of whether it is industrial or any other kind of policy. In this sense, criticism of industrial policy interventions should not be directed at the policy per se, but rather on whether it is justified and appropriate in terms of the existent market failures. Ruling out interventions of this type just because they failed to bear fruit is not enough reason. That policies did not achieve their goals might have been because they were not addressing the underlying market failure.

In the midst of the re-emergence of the industrial policy debate, I believe the two most important questions to be asked are: what went wrong back then? And, perhaps most importantly, what have we learned in the decades since?

These questions, and others, are addressed in the newest Inter-American Development Bank (IADB) annual report “Rethinking Productive Development.” The report revives this discussion while carefully analyzing some of the (good and bad) experiences of the past. Co-edited by IADB’s Gustavo Crespi, Eduardo Fernandez-Arias and Ernesto Stein, the report provides a rigorous, yet intuitive, framework to think about policies that aim to boost productivity in the region.

The report analyzes policies that aim to increase productivity in developing countries by correcting market errors in areas related to innovation, entrepreneurship, labor markets, finance, clusters and diversification of the economy.

The book does a great job in reviving these topics, which are critical to overcome the “productivity curse” many developing countries are in. Perhaps, most importantly, it presents insightful evidence-based thoughts, which set the stage for an open discussion on industrial policy as a way to induce productivity. This type of debate is not only relevant for the Latin-American context, but for the developing world as a whole.