Industrial Policies and Economic Development

Many currently and previously developing countries have adopted industrial policies that push resources towards certain "strategic" sectors, and the economic reasoning behind such polices is not well understood. In this paper,... [ view full abstract ]

Many currently and previously developing countries have adopted industrial policies that push resources towards certain "strategic" sectors, and the economic reasoning behind such polices is not well understood. In this paper, I construct a model of a production network where firms purchase intermediate goods from each other in the presence of credit constraints. These credit constraints distort input choices, thereby reducing equilibrium demand for upstream goods and creating a wedge between the potential sales (“influence”) and actual sales by upstream sectors. I analyze policy interventions and show that, under weak functional form restrictions, the ratio between a sector's influence and sales is a sufficient statistic that guides the choice of production and credit subsidies. Using firm-level production data from China, I estimate my sufficient statistic for each sector and show that it correlates with proxy measures of government interventions into the sector. Using a panel of cross-country input-output tables and sectoral production tax rates, I show that the tax rates for developing countries in Asia also correlate with the model-implied intervention measure.