A changing climate for industrial policy

Industrial policy has a key role to play in the transition to a resource-efficient, low-carbon growth trajectory. Wilfried Lütkenhorst, Managing Director of the Regional Strategies and Field Operations Division of the United Nations Industrial Development Organization (UNIDO), considers the implications.

***

The return, renaissance, rediscovery or comeback of industrial policy has been widely heralded. This is good news. And let’s be honest: industrial policy has never left the scene. It has been practiced in varying shapes and forms in all countries, developed and developing alike. The issue really is: are various policy instruments applied in an uncoordinated, ad-hoc, and at times clandestine manner? Or are they openly embedded in a clearly formulated and communicated strategy behind which a country – with all relevant public and private stakeholders – can unite and move forward? It is this latter notion of an agreed vision (where do we want our economy to go and how do we get there?), which is back on the agenda with a vengeance. Sadly, it has taken a major global economic crisis to drive home the point that markets are all about allocation of resources and efficiency but, in and by themselves, do not take care of long-term societal objectives.

‘New industrial policy’

When looking at the policy debate today, in many ways, there is a strong sense of déjà vu. Some of the discourse among economists is revisiting issues already battled over in the 1980s: whether to accept or challenge an economy’s comparative advantages; to just set framework conditions or pick and promote winners; to steer foreign investment into priority sectors or allow an indiscriminate inflow; to nurture infant industries or let the forces of globalization prevail, etc.

At the same time, there is, in fact, widespread agreement on key features of a so-called ‘New Industrial Policy’, among them:

• that framework conditions such as macro-economic stability, a conducive business environment and openness to trade are a necessary point of departure;
• that a shift from autonomous government action to a strategic public-private dialogue is essential;
• that the focus should move away from setting pre-defined outcomes to getting the policy process right (Dani Rodrik’s notion of industrial policy as a “discovery process”);
• that, all too often, there is a fixation with formulating fancy strategies, while neglecting the institutional capacities required for their effective implementation;
• that we need to move from dogmatic prescriptions (Washington Consensus) to a sense of pragmatism, to a readiness to ‘think outside the box’, and to innovate and experiment (sometimes labelled now as the ‘Beijing Consensus’ – a term coined by Joshua Cooper Ramo in 2004); and
• finally, that we need to maintain a healthy dose of realism and modesty. History is littered with well-crafted industrial policies that failed to achieve their stated objectives and became captive to special interests groups.

Climate change: global market failure

All of the above is fine and dandy. Now enter climate change as the real game changer: as the “defining trend of our time” in the words of the UN Secretary-General; as the “greatest market failure the world has ever seen” in the eyes of Sir Nicholas Stern. Remember political economy 1.01? Isn’t market failure one of the fundamental justifications for policy interventions – unless, of course, the risk of policy failure is considered as even bigger?

I would indeed argue that industrial policy today cannot be relevant, cannot be effective, and cannot be credible, unless it is explicitly framed in the context of natural resource scarcity. We need to factor in global (and, by the way, also regional and local!) limits to climate change, lest we allow an irreversible tipping point to be reached. And there are positive signs that this is beginning to be understood by both economists and, importantly, by policymakers, particularly in emerging economies. Here a just a few illustrative examples:

• In India, there is growing awareness that climate-related factors will hit the poorest segments of society the hardest, and are likely to lead to a significant slowing down of GDP growth. The nation’s environment minister sees India as the country most vulnerable to climate change. A debate on green growth and green energy is intensifying – with or without global agreements.
• In China, massive investment is being undertaken in energy efficiency, renewable sources of energy, and green technologies in general, with over US$60bn. targeted for developing hybrid and electric car technology, and further improving rail transport and electricity grid infrastructure, as well as for a new 10-year clean energy plan. According to the country’s State Environmental Protection Agency, as much as 15% of GDP is lost annually due to various types of environmental pollution.
• In Viet Nam, extreme weather conditions and rising sea levels are considered a threat to agricultural and industrial production in half the country, seriously jeopardizing future economic growth. The Government has responded by integrating these concerns into the development plans of all ministries.
• Finally, Brazil is re-discovering the “green” merits of its long and well-established policy to promote renewable fuels. This policy dates back to the early 1970s, and has led to ethanol now accounting for over 50% of light vehicle fuel demand in the country.

Low-carbon growth

If we accept the premise that the transition to a resource-efficient, low-carbon growth trajectory is imperative, and that industrial policy has a key role to play, then what are the implications?

First and foremost, we need to start from the premise that multiple objectives govern any industrial policy. Policy formulation and implementation is always embedded in a political and social context from which it derives its legitimacy. While considerations of climate change and resource efficiency are crucial, other objectives have to be factored in as well. These range from poverty reduction to food and energy security, to job creation, reduction of regional and income inequalities, stimulation of growth and productivity, encouragement of innovation and entrepreneurship, etc. Thus, it is critically important to direct research efforts towards exploring the relationship between these different objectives. What are the complementarities and what are the trade-offs, for example, between energy efficiency, productivity and cost effectiveness; between pushing renewable sources of energy and broadening access to energy; between adaptation measures, patterns of industrial location, and regional disparities; and between CO2 mitigation action and industrial profitability? Unless a firm foundation is created for evidence-based policy decisions, uncertainty and speculation will prevail.

Secondly, the conventional focus of industrial policy on promoting priority sub-sectors (be it textiles, food processing or electronics) may need to be revisited and subsumed under an orientation towards resource-efficient technologies across the entire spectrum of sectors. This would, among other things, call for enhanced benchmarking efforts, an alignment of research and development incentives and innovation systems with the need to reduce climate impacts, and access for enterprises to financial instruments, including venture capital, for the funding of environmentally-friendly investment.

Thirdly, investment promotion approaches will have to be revisited. Foreign direct investment (FDI) is the key transmitter of new technologies in many developing countries. To a large extent, FDI inflows determine the future technology scenario, the pattern of industrial production and linkages, as well as learning effects for domestic business. By applying the right policy instruments, investments could increasingly be geared towards resource efficient technologies. In this context, industrial zoning approaches targeting green and clean investors (aimed at demonstration and spill-over effects for local businesses) or, conversely, targeting polluting industries (to allow economies of pollution abatement), could assume particular importance.

Fourthly, it should be acknowledged that different groups of countries face distinct challenges, and that policy priorities should reflect this fact. In Least Developed Countries, adaptation strategies will often be more pressing than mitigation needs, and energy access goals are likely to be more urgent than energy efficiency considerations. But the same argument cannot be applied to middle-income countries. Here, energy efficiency gains in established industries (specifically heavy industries like steel, chemicals and the like) need to receive priority, and are widely considered to be low-hanging fruits. Yet these fruits still seem to require inputs in terms of information, awareness, and incentives, in order to actually get picked.

Finally, there are general and cross-cutting challenges, such as the greening of trade (i.e., the reduction of the carbon footprint of entire value chains) and, in particular, the promotion of technology transfer through a variety of mechanisms ranging from FDI to official development assistance and the Clean Development Mechanism. State-of-the-art green technologies tend to be high-tech and costly. Who is going to pay for the transfer of proprietary technology? Unless an international solution for the funding challenge is found, many developing countries wanting “to go green” may face a genuine dilemma. Hence, there is a strong case for global action, and some degree of international policy coordination.

The high road

Industrial policy has always been faced with the perils of uncertainty, and with the need to make assessments and judgments that try to anticipate and shape desired future scenarios. However, with the new dimension added by a global context of climate change and resource scarcity, the genuine risk of a global catastrophe “makes the most powerful case for strong climate policy”, as recently stressed by Paul Krugman in the New York Times. While industry is part of the problem (accounting for 36% of CO2 emissions), it also offers great opportunities. There will be no solution without developing and diffusing new industrial technologies that consume fewer resources, reduce carbon emissions, abate pollution, and reuse and recycle the waste generated.

Establishing the framework for allowing this to happen, encouraging responsible production and consumption, and ultimately defining a sustainable path to prosperity, are the challenges to which industrial policy today must rise. The gradual decoupling of economic growth from environmental degradation and resource depletion defines the high road to industrialization that countries should strive for – both to save our planet, and to define new frontiers of competitiveness.