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4 Industrial Policy and Financing Industrial Development

4.1 Elements of an Effective and Coherent Industrial Policy Framework

(a) Supporting and Promoting Private Sector Development

The State has a vital role in supporting the private sector to channel its investment resources to specific sectors or activities which have a significant effect on structural change. Government support can address constrains to entrepreneurial activities, such as infrastructural deficits in technology, skills, transport or energy. In addition, the State should ensure an investment friendly atmosphere where firms can thrive in. Recent empirical analysis on industrial policy accords the government even a more challenging role in supporting domestic firms. The State has a crucial responsibility in challenging domestic firms to increase their production output and export performance. Government support, in terms of competitive incentives and subsidies should therefore be made conditional on achieving certain conditions which will promote productivity and international competitiveness in domestic firms. Therefore, promoting the private sector necessitates instituting 'discipline' and ensuring that firms achieve set targets in order to enjoy government support.

(b) Recognizing country and sector specific conditions

In the design and implementation of industrial policy, it is vital to take into account country heterogeneity and specific sectoral conditions. Industrial policy instruments should be tailored to fit the needs and challenges of each country, and governments should not adopt a one size fits all approach. Policy makers need to take into account differences in country endowments, comparative and competitive advantage, initial conditions, political climate and infrastructural requirements in determining the form of industrial policy to implement. Therefore, recognizing the importance of country specific and context specific policies is important in avoiding industrial policy failure. Duplication of policies from other countries without adapting them to local conditions can lead to adverse effects. Effective industrial policy should therefore be country and context specific.

(c) Visionary and strategic leadership as well as re-orientation of development perceptions

An important aspect of sound industrial policy is political support from the highest State organs and government officials. Successful experiences of industrialization in both developed and developing countries highlight the need for visionary and strategic leadership in promoting productive economic sectors through selective policy interventions. A smart bureaucratic leadership is a necessary condition in promoting industrial development. In addition, ensuring coordination of industrial policies across government ministries, departments and industrial policy institutions is key in avoiding duplication of responsibilities and contrasting of policy objectives and targets. Therefore governments should ensure clear and well-spelled out framework across government institutions. To this end, the formation of an autonomous institution which overseas industrial policy in a country is key in facilitating coordination of policies and ensuring transparency and accountability among the different institutions involved in implementing industrial policy.

(d) Implementing both horizontal and vertical policies

In order to spur industrial development, there is need to simultaneously implement horizontal and vertical industrial policies. Horizontal policies are generally those which promote industrial development across all sectors. They consist mainly of addressing infrastructural deficits, promoting a stable macroeconomic and political atmosphere which supports both domestic and foreign investments, human capital formation and technology upgrading. Vertical policies, on the other hand, include those policies which are targeted to specific sectors/firms or products in the economy. African policymakers should ensure an appropriate mix of horizontal and vertical policies, and gradually ensure that as domestic firms upgrade, the type of policies implemented are adjusted accordingly to reflect the need of the industry.

(e) Designing and implementing achievable industrial policy targets

Past industrialization experiences in most African countries highlight the adverse effects of formulating ambitious and unattainable industrial policies. Neglecting a country's resource limit can result to unsustainable subsidies and undesirable outcomes. In addition, disregarding a country's comparative and competitive advantage in designing and implementing industrial policy can lead to policy failure. Most African countries have in the past defied their comparative and competitive advantage, promoting capital intensive sectors. It is thus crucial for countries to take into account their endowments such as natural resources and abundant labour in the designing industrial policies. This will ensure that economies capitalize on readily available resources to add value and upgrade up the production structures. This in turn would result to increased competitiveness and productivity in the industry.

(f) Promoting transparency and accountability

Given that industrial policy necessitates selecting specific sectors, products or firms, it is crucial to ensure that the risk of political capture and rent seeking is mitigated. Industrial policy decisions should be made in a transparent manner, and should encompass wide consultations with key stakeholders, especially the private sector. In addition, there should be clear benchmarks on how to channel support to certain sectors or firms, and the criteria for judging success or failure should be well spelled out. Evidence from the East Asian countries show that export performance can be used as an indicator of performance. Sunset clauses which terminate support to non-performing firms should also be enacted, and frequent monitoring and evaluation should be conducted to ensure that government support is channelled to support feasible and viable sectors or firms which meet the set indicators.

(g) Adopting appropriate monetary and fiscal policies

Promoting efficient industrial development outcomes also depends on the degree to which monetary and fiscal policies are aligned with industrial development. High inflation, for instance, has a negative impact on investment, as it signals risks and uncertainty in the economy. Exchange rate policies also have an impact on providing incentives to investors to engage in the production of manufactured goods. It is therefore important for countries to link their monetary, fiscal and industrial policies in order to promote synergies. Promoting competitive exchange rate policies can boost export competitiveness and providing incentives to firms to re-allocate their production structures to high productive sectors such as manufacturing and industry. Avoiding overvalued exchange rates as well as exchange rate volatility can also have a significant impact on manufacturing. In addition, monetary and fiscal policies should also be targeted to promoting financial sector development. There is need to improve access to credit, especially for small and medium enterprises by ensuring that interest rates and collateral requirements do not deter investments in high productive economic sectors.

(h) Promoting regional integration and intra-African trade

Regional integration provides numerous opportunities for Africa countries to promote industrial development. Through the harmonization of national policies across countries, regional integration can lead to a reduction in direct and indirect trade costs and enhance competitiveness of domestically manufactured goods. In addition, pooling financial resources at the regional level can address infrastructural deficits, especially in the transport and energy sectors, leading to reduced production costs. Given the continent's growing population, as well as high income growth, the continent provides a huge end-market for manufactured exports. Therefore, the region can be a significant source of consumer demand and labour for manufactured goods. Recent studies show that trade among African countries is less restrictive, and highly diversified. Unlike Africa's exports to traditional and emerging markets, exports to African markets are tilted towards manufactured and high value added products. According to ECA and AUC (2014), around 40 % of intraAfrican trade comprised manufactured exports between 2010 and 2012. This implies that facilitating trade among African countries by addressing the prevailing high trading costs and barriers can lay the foundation for industrial development on the continent.

(i) Boosting entrepreneurial ventures and investment

Policies which are designed and implemented to boost entrepreneurial investments constitute a key ingredient of any industrial policy framework. It is therefore important to ensure that government interventions promote the acquisition of managerial and technical skill, especially to small and medium enterprises. A key policy instruments comprises the provision of competitive incentives to firms to enable them channel their investment resources to the industrial sector. The design and implementation of incentives should however be conducted in a manner that does not attract rent seeking and corruption. Incentives should also encompass a sunset clause, and should be based on measurable targets and achievement indicators.

(j) Promoting innovation and technology upgrading

Most African countries are characterized by low levels of technology advancement and production techniques. Policies to accelerate technological progress and upgrading remain a vital component of industrial policy. Experiences of successful industrial policy in both developed and developing countries show that promoting the acquisition of modern technology and promoting science and technology is key in fostering industrial development. Therefore, the design of industrial policy should take into account channels which promote technology knowledge and accumulation. Local content policies, subsidies for technological imports and attracting FDI are seen to be a useful policy instruments in this regard.

(k) Policies to promote education and skills formation

Supplementing policies geared at accelerating innovation and technology is the need for human capital formation and skills development. Human capital and technology advancement are two key inputs in the industrialization process. Promoting skills upgrade will ensure that domestic firm have a high quality labour force which can engage in the production of competitive products. Therefore policies which align education curriculum with the needs of the industrial sector are vital. Configuring and re-orienting education system towards scientific and engineering courses can be instrumental in the development of appropriate human capital. In this regards, establishing training institutions and providing incentives for firms to engage in on the job training are key in accelerating skill formation.

4.2 Financing Industrial Development

Designing and implementing industrial policies is necessitates huge financial implications. Industrialization is a costly venture, and African countries need to mobilize sufficient resources to finance industrialization. Governments therefore have a key role to mobilize public investments and channel them to key strategic areas such as improving infrastructural deficits, improving education and skills and promoting innovation as well as technology diffusion. Therefore, the efficiency and extent to which African countries will successfully achieve their industrialization goals greatly hinges on the efficacy of their resource mobilization strategies. Given the heterogeneity of African countries and their different levels of industrial development, various sources of finance provide opportunities to mobilize resources. These include mobilizing domestic resources, borrowing from financial institutions, FDI, official development assistance and central bank reserves.

(a) Mobilizing domestic resources for industrialization

Successful industrial development necessitates local ownership of the process and outcomes. Countries are more likely to align their industrial strategies with their long term development plans if there is government policy space. Therefore, mobilizing domestic resources, especially taxes and remittances can constitute key avenues of financing industrialization. Apart from most resource-rich countries, African countries are characterized by low domestic resources mobilization. Domestic savings and taxes constitute a small share of the government's total revenue, constraining the capacity of the government to finance productive investment. Several factors have been advanced to explain the low levels of domestic resource mobilization in the continent. They include low income per capita, narrow tax bases, inefficient tax administrative systems, the hefty reliance on a narrow set of taxes and illicit capital flows. Therefore, there is need for African governments to institute sound policies which promote resource mobilization by addressing the above factors. Developing sound fiscal policies, deepening financial sector development and curbing illicit capital flows are some of the measures which can enhance revenue collection.

(b) Borrowing from financial institutions

Industrial development can also be financed through borrowing from both domestic and international financial institutions. Borrowing from international markets is usually daunting for most African countries, as these funding is normally focused on short-term lending. In addition, due to high risk premium and lack of credibility, raising money in international markets has resulted to undesirable outcomes. Therefore, one of the key sources of financing industrialization are development finance institutions and national development banks. Experiences from the rapidly industrialization experiences of the East Asian countries underscores the role of national development banks in providing long term finance for industrial development. As a result, African policymakers should establish or strengthen existing development banks in order to provide entrepreneurial funding for investment, especially to small and medium enterprises.

(c) Promoting Foreign Direct Investment

Investment resources for industrialization can also be obtained from attracting foreign direct investment. FDI is one of the channels which can foster technological innovation and diffusion from developed to developing countries. It can also boost local production capabilities through positive spillover effects of managerial and technical skills. However, FDI flows into African countries have exhibited a pattern which is not conducive for structural change. There is mounting evidence which shows that FDI inflows are channelled to countries which are resource-rich. Extractive sectors such as oil and mineral resources consist the bulk of FDI destinations in most African countries. As a result, FDI has not had a profound impact on promoting industrial development, rather, it has been a catalyst in promoting the exportation of raw commodities. In this regards, there is need for policymakers to craft policies which channel FDI to priority sectors. Promoting joint investment ventures between domestic and foreign investors is one of the key ways of establishing linkage development in the domestic economy.

(d) Official Development Assistance

Official development assistance constitutes a potential source of finance for industrialization. This is especially important for African countries whose ability to raise resources in international financial institutions remains limited. ODA can therefore provide the much needed resources to finance infrastructure development which is fundamental for any industrialization strategy. However, ODA flows to most African countries are not targeted for this purpose. A significant portion of ODA is channelled to financing social sectors such as education and health. To capitalize on these resources, it is crucial for policy makers to ensure that industrial development constitutes one of the goals and targets of ODA. Ensuring that donor priorities are aligned with industrialization and promotion of high growth sectors is a priority policy imperative for most African countries.

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