Industrial policy for economic and social upgrading in developing countries

Economic and social upgrading are two sides of the same coin. One without the other will not work.

Hansjörg Herr outlines four reasons why economic upgrading in all countries (including developed countries) requires an industrial policy:

1. The investment needed to establish new products or technology is risky and will not be carried out by private investors without government guidance or help.
2. Big technological changes need complementary government efforts, such as in the field of education and technical help.
3. Government support is needed to cope with the internal and external economies of scale in many cases.
4. Firms must be forced by government to consider the consequent ecological problems of their production

The author further argues that there are merits to free trade, especially the many chances for developing countries to easily move into industrialization by taking over simple tasks in global value chains. But integration into global markets without active government policy restrains developing economies from catching up with developed countries. The primary danger is that developing countries are pushed to low-tech labour-intensive productions according to their comparative advantages. Foreign direct investment, even without its negative side effects, will also follow the logic of comparative advantages and alone cannot lead to catching-up processes.

Development needs to go beyond exploiting comparative advantages. Only an active comprehensive industrial policy, including establishing institutions to define and implement the policy, can trigger economic upgrading that is sufficient for catching up. Industrial policy should be coordinated on a national level, the paper concludes, but there is much room for comprehensive economic and social upgrading on regional levels, cluster levels and in single industries.