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2 Related Literature

2.1 The Justification for Industrial Policy

The justification for industrial policy lies on the fact that the government has a central and pivotal role in fostering structural change in an economy. By accelerating the transfer of resources (capital, labour and knowledge) from low to high productive sectors, industrial policy has the potential to promote and sustain inclusive economic growth. Given this proposition, both theoretical and empirical literature underscores the importance of industrial policy in addressing distortions that constrain structural change and socially efficient outcomes. The first distortion relates to the presence of market failures; the second to coordination failures, the third to knowledge spillover and externality problems, and the fourth to technological accumulation and acquisition of knowledge.

Conventional development theories postulated that markets are efficient in the allocation of resources across different sectors and State interventions are not required to accelerate structural change. However, it is increasingly becoming evident that market forces do not necessarily lead to efficient outcomes and State intercessions are key in correcting this. Both theoretical and empirical evidence shows that, especially in the context of developing countries, there exist substantive market failures, especially in regards to information and cost discovery externalities (UNCTAD and UNIDO 2011).

According to Hausmann and Rodrik (2003), due to information externalities about the profitable goods which a country can produce, the first firm to invest in cost discovery bears all the costs, while rival firms learn from the outcome of the first entrant. Due to this free riding problem, investment is sub-optimal as no firm is willing to make any investment in the discovery of new products. In this case, industrial policy can be used to promote entrepreneurial entry and investment, for instance, through subsidies and compensation for innovation (Lin and Chang 2009).

Another type of market failure relates to environmental externalities. This arises as firms, motivated by profits, do not incorporate pollution and environmental degradation costs in their investment decisions. Industrial policy can be relied to correct this, by supporting the development of green technologies, and production process which are environmental friendly, resource efficient and low carbon intensity (Hallegatte et al. 2013).

The second rationale for industrial policy arises due to the presence of coordination failures (Pack and Saggi 2006). Coordination failures arise as the feasibility and profitability of most economy activities is contingent on the existence of complementary investments. This implies that a firm is willing to invest in a particular sector if there are complementary firms which support its production process. In the absence of such environment, entrepreneurial and domestic production may be adversely affected. Therefore, the State has a role to play in promoting and coordinating collective investment decisions from independent actors. Industrial policy thus emerges as a tool for pooling investment ventures which would otherwise deter investment and the entry of entrepreneurial firms (Altenburg 2011).

Besides the need to address market and coordination failures, industrial policy can affect a country's technological accumulation and learning among firms. In developing countries, domestic firms rely on existing technologies to boost their technological capabilities. However, adopting technology is usually costly and time consuming, as firms do not have information on existing global technologies. In addition, inter-firm spillovers may deter firms from investing in technology or knowledge accumulation as workers are able to move from one firm to another. Given that knowledge is a public good whose usage is non-rivalrous, the market becomes an inefficient provider, necessitating government intervention (Stiglitz et al. 2013). Empirical evidence tends to underpin that income convergence of East Asian countries towards that of developed countries was accelerated by industrial policies which promoted constant learning and knowledge accumulation among firms (Rodrik 2009).

A final justification for industrial policy is its role in fostering structural change by addressing social development challenges such as job creation, and income distribution. By addressing regional disparities and promoting labour intensive production, industrial policy can have a significant impact on social welfare, inclusive growth and improved standards of living through increased income generation.

2.2 The Importance of the Manufacturing Sector

Several theoretical justifications have underscored the importance of structural change through promotion of the manufacturing sector. First, income elasticity of demand is higher for manufactured than primary products, providing opportunities for. Second, compared to traditional exports, manufactured goods are less vulnerable to price volatility and external shocks. Prices for manufactured products rise faster than those of primary commodities. Third, productivity gains emanating from backward and forward linkages between the manufacturing sectors and other sectors of the economy are more pronounced, increasing the scope for technology transfer and diffusion as well as managerial and technological spillovers (ECA and AUC 2013). Besides this linkage channel, the manufacturing sector can act as an engine of economic growth through capital accumulation, knowledge and managerial skills transfer, increasing economies of scale and learning by doing effects. Finally, a well-developed manufactured sector creates high quality employment opportunities with higher income effects in the manufacturing sector as well as in other sectors of the economy through input output linkages and vertical integration.

2.3 Lessons from Past Industrialization Efforts in Africa

Industrial policy in most African countries is not a new phenomenon. During the 1970s countries attempted to spur industrial development by implementing the import substitution policies (ISI). A decade later, the structural adjustment programme (SAPs) were carried out, and so were the poverty reduction strategies (PRS) in the 1990s. Although different governments implemented various industrial policy strategies and interventions, there is a consensus that industrialization and structural change did not occur, and in fact the industrial base in some countries was eroded (ECA and AUC 2013; UNCTAD and UNIDO 2011). Nonetheless, an analysis and examination of these three industrialization phases provide crucial policy lessons which African countries can learn from in the formulation of their own industrial policies.

(a) Local ownership and leadership of industrial development is vital

The experiences of early industrialization in Africa underscore local ownership of the process as an important factor which can determine its success or failure. Although policy advice from external, and usually foreign sources is useful in terms of capacity building, effective policy design requires African countries to take charge and leadership of the process. Policy space is important, and without it, countries are unlikely to follow the path which will lead to structural change and improved standards of living. The design and implementation of the ISI, SAPs and PRS was often done without any consultation with national governments. As a result, the imposition of these development policies contributed to their failures. It is therefore important for African countries to be proactive in aligning foreign advocated policies which their own development plans and industrial strategies.

(b) Addressing Structural impediments is of the essence

One of the key reasons attributed to the failed strategies regards the neglect of structural factors in the design and implementation stages of the industrial development processes. Promoting successful industrial development requires policies which address deficiency in soft and hard infrastructure. Most African countries are marked with poor transport, communication and energy infrastructure, inadequate human skills, technological constrains and low levels of public and private investment. Neglecting these structural factors can result in a weak industrial base and contribute to inefficient policies. This was often the case as these strategies were not targeted at improving structural weakness inherent in most economies. It therefore emerges that designing efficient industrial policy necessitates addressing infrastructural deficit which lay the platform to support high productive investments.

(c) Promoting technological accumulation and innovation of domestic firms is crucial

Past industrialization attempts in most countries did not focus on building the capacity of domestic firms through technology advancement. As a consequence, most firms were not competitive and exhibited low productivity. As a result, fierce competition, even in the presence of protectionist policies, led to the collapse of domestic industries. It is increasingly becoming evident that promoting technology and innovation is key in boosting competitiveness of manufactured products and building capability in domestic firms. To this end, policies which foster innovation, technology diffusion and upgrading constitute a key ingredient in the design of any coherent industrial policy framework.

(d) Export oriented industrialization is decisive

Promoting structural change through industrialization also necessitates sound trade policies. Inward oriented industrialization policies, such as those early implemented, are unlikely to be sustainable in the medium to long run. Domestic markets in the continent are small, and the demand generated for industrial products is inadequate to trigger investment in high productive sectors. Early industrialization policies neglected the role of trade, especially in the context of intra-African. It was believed that African countries were similar in their export products and could therefore not trade with each other. There were no initiatives aimed at facilitating trade amongst countries in the region through the removal of tariff and non-tariff barriers. As a result, low purchasing power in most countries led to reduced effective demand for manufactured products. It is now increasingly becoming clear that expanding end markets for industrial products presents opportunities for firms to enjoy increasing economies of scale, learn by doing and join regional value chains which are less demanding compared to global chains. Therefore, it is important to ensure that trade policies are a central ingredient of any industrialization plans and strategies.

(e) Consultation with the private sector is central

Designing coherent industrial development strategies necessitates consultations with key stakeholders in the economy, especially the private sector. Past experiences show that most governments adopted a top-down approach to industrialization. The government was the main actor, with little or no involvement of other players in the design and implementation stages of industrial policy. Recent experiences show that the private sector is a key engine of economic growth. It is associated with investments in high productive and capital intensive sectors of the economy. This was one of the aspects lacking from early industrialization strategies implemented in most countries. It is therefore key to ensure that policy design and implementation encompasses the involvement of the private sector. This is normally important as the government does not have all the information regarding the industrial market. Therefore, working with the private sector can provide crucial information regarding opportunities and challenges which can aid decision making by policy makers.

 
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