Industrial Strategy: Four Rationales

What can local policymakers learn from this? As expected, academics spend a good deal of time debating the definitions of ‘industrial strategy’ and ‘innovation policy’. Much of the literature is also focused on national government, rather than subnational actors.

There are two more useful contributions. First, academic authors have developed a number of rationales for doing industrial policy, and associated roles for the state. Much of this is helpful for policymakers developing theories of change and clarifying objectives. Second, the empirical literature talks in detail about policy governance and management tools, and provides heuristics / ‘how to’ design principles that derive both from theory and from real-world experience.

In the main body of this document, we draw on a number of these heuristics to develop 10 principles for local industrial strategy. Below, we provide a quick review of the main rationales for policymakers to conduct industrial policy in the first place.

1. Supporting entrepreneurs / The Schumpetarian view

One rationale for industrial policy comes from Joseph Schumpeter, the pioneering theorist of entrepreneurship. [9] Schumpeter makes two central points. First, new ideas and innovations change the economy and society through a process of ‘creative destruction’. Transitions from one technological paradigm to another are often chaotic, and have winners and losers, even if the long-term result increases overall welfare. [10] Second, the entrepreneur is the central figure in this process, as the transformer of new ideas into new products and services. In this scenario, the State has important strategic roles in supporting entrepreneurship and the creation of new ideas; and in compensating the losers from creative destruction. In practice, this could involve a mix of competition policy, support for startups and scale-ups, welfare programmes for ‘losing’ groups and ABIs for ‘losing’ communities and places.

2. Ideas, skills and the state / Endogenous growth theory

A second rationale comes from endogenous growth theory. In this picture, human capital and new ideas are important drivers of long term economic growth. [11] New knowledge and innovations help push the technological frontier forward; these ideas ‘spill over’ from inventors to the rest of society, which can then make productive use of them. But at the same time spillovers also mean that inventors cannot capture the full value of new ideas, discouraging innovation. Worse, research and experimentation are risky (ideas may not work out), expensive (e.g. accessing skilled people or specialist infrastructure), and may require cooperation to pay off (e.g. setting common technological standards). Taken together, these market and co-ordination failures mean that societies will typically ‘underinvest’ in innovative activity. [12] In turn, this suggests multiple roles for the State, in funding and incentivising basic research in universities and businesses; subsidising advanced education and training; supporting knowledge transfer, networks and collaboration; and through regulation, standards and competition policy. In practice, the extent of policy involvement will vary from sector to sector. The standard policy mix involves a series of cross-sector (‘horizontal’) interventions along the lines above. A more interventionist, active state approach sees market failures as the norm in many sectors, especially knowledge-intensive and ‘frontier’ activities, and develops more intensive, ‘vertical’ support and public-private partnership working.

3. Public-private co-creation / Innovation systems

Innovation systems theorists argue that the economistic approach of endogenous growth frameworks is too thin to explain actual patterns of innovative activity and the roles of government and other public actors. Rather, we should see innovation as the product of a system of entrepreneurs, firms, government and other institutions, which collectively shape levels and characteristics of innovative activity. [13] This third rationale emphasises institutions as both actual entities (such as universities and public research agencies) and more intangible norms, customs and rules that influence how communication and interaction occurs. Equally, it highlights the need to understand the roles of different actors in a given national or regional system, and within specific production systems, such as clusters or value chains. [14] Many of these may spill over local administrative boundaries, or national boundaries. It also directs policymakers to fix capacity problems, align incentives and tackle sub-optimal behaviour, with a focus on good governance and management. [15] In one version of this scenario, the State takes on similar roles to the active state approach above, with an emphasis on public-private networking and co-ordination (exemplified by DARPA or the Fraunhofer Institutes). A more hands-on version is the ‘entrepreneurial state’ approach, in which government takes a strategic role in picking key sectors, technologies and activities, and directs the most important activity through mission-focused programmes. [16]

4. Industrial policy for cities and regions / Smart specialisation

A fourth rationale for industrial policy derives from the smart specialisation concept. [17] This approach draws from the three previous rationales but derives implications for regional and local policymakers. First, it emphasises the importance of ‘entrepreneurial discovery’ in national long-term economic growth, particular technology-led growth, and highlights the need for countries to identify their own strengths and build on these advantages through a range of national policy measures. Second, it points out that the resources for innovation-led growth are unevenly spread across places. Worse, over time both Schumpetarian and endogenous growth processes are likely to drive up disparities between places. This picture is complicated by the fact that innovation systems and value chains sit across administrative borders, and because policies also have spillover effects (for example, if place X trains people who then move to place Y). Nevertheless, smart specialisation advocates suggest that the smart specialisation concept provides a useful basis for place-based responses. At the local level, different places need different policy mixes. Places need to a) prioritise around their strengths; b) have regard to spillovers between places c) set up sound governance structures d) produce a shared vision e) select a limited number of priorities, and f) design specific interventions for these. Smart specialisation design guides emphasise the importance of clear processes, experimentation, robust evaluation and systems that allow policymakers to drop failing interventions. [18]

This blog was written by Dr Max Nathan, City-REDI, University of Birmingham and Deputy Director, What Works Centre for Local Economic Growth. 

It was first posted here as part of a What Works Centre piece, part of the Centre’s industrial strategy design guide.

It features in our 10 Principles report, which forms the centrepiece of a major programme of work with central and local decisionmakers in 2018 and 2019.

Endnotes
[1] Lucas R. (1988) On the Mechanics of Economic Growth. Journal of Monetary Economics 22: 3–42; Romer P. (1990) Endogenous Technological Change. Journal of Political Economy 98: 71–102.

[2] Aghion P, Blundell R, Griffith R, et al. (2009) The Effects of Entry on Incumbent Innovation and Productivity. Review of Economics and Statistics 91: 20–32; Perez C. (2010) Technological revolutions and techno-economic paradigms. Cambridge Journal of Economics 34: 185–202; Schumpeter J. (1962) The Theory of Economic Development, Berlin: Springer.

[3] Aghion P, Dewatripont M, Du L, et al. (2012) Industrial Policy and Competition. NBER Working Paper 18048. Cambridge, Mass: NBER; Jaffe A. (1996) Economic analysis of research spillovers: Implications for the Advanced Technology Program. Economic Analysis: 1–14; Lerner J. (2009) Boulevard of Broken Dreams, Princeton: Princeton University Press; Tirole J. (2017) Economics for the Common Good, Princeton: Princeton University Press.

[4] Bresnahan T and Gambardella A. (2004) Building High-Tech Clusters. Cambridge: CUP; David PA. (1990) The Dynamo and the Computer: A Historical Perspective on the Modern Productivity Paradox. The American Economic Review 80: 355–361; Freeman C. (1991) Networks of innovators: A synthesis of research issues. Research Policy 20: 499–514; Mazzucato M. (2013) The Entrepreneurial State. London: Anthem.

[5] Harrison A and Rodríguez-Clare A. (2009) Trade, Foreign Investment, and Industrial Policy for Developing Countries. National Bureau of Economic Research Working Paper Series №15261. Cambridge, MA: NBER; Wade R. (2010) After the Crisis: Industrial policy and the developmental state in low-income countries. Global Policy 1: 150–161.

[6] Rodrik D. (2004) Industrial Policy for the Twenty-First Century. CEPR Discussion Paper 4767. London: Centre for Economic Policy Research.

[7] Duranton G and Kerr W. (2015) The Logic of Agglomeration. NBER Working Paper 21452. Cambridge, Mass: NBER; Chatterji A, Glaeser E and Kerr W. (2014) Clusters of Entrepreneurship and Innovation. Innovation Policy and the Economy 14: 129–166; Kline P and Moretti E. (2014) Local Economic Development, Agglomeration Economies and the Big Push: 100 Years of Evidence from the Tennessee Valley Authority. The Quarterly Journal of Economics 129 275–331; Moretti E. (2012) The New Geography of Jobs, Boston: Haughton Mifflin Harcourt.

[8] Asheim BT, Smith HL and Oughton C. (2011) Regional Innovation Systems: Theory, Empirics and Policy. Regional Studies 45: 875–891; McCann P and Ortega-Argiles R. (2013) Modern regional innovation policy. Cambridge Journal of Regions, Economy and Society 6: 187–216; Saxenian A-L. (1994) Regional Advantage: Culture and Competition in Silicon Valley and Route 128 Cambridge, MA: Harvard University Press; Storper M. (1997) The Regional World: Territorial Development in a Global Economy, New York: Guilford.

[9] Schumpeter J. (1962) The Theory of Economic Development, Berlin: Springer.

[10] Aghion P, Blundell R, Griffith R, et al. (2009) The Effects of Entry on Incumbent Innovation and Productivity. Review of Economics and Statistics 91: 20–32; Perez C. (2010) Technological revolutions and techno-economic paradigms. Cambridge Journal of Economics 34: 185–202; Schumpeter J. (1962) The Theory of Economic Development, Berlin: Springer.

[11] Lucas R. (1988) On the Mechanics of Economic Growth. Journal of Monetary Economics 22: 3–42; Romer P. (1990) Endogenous Technological Change. Journal of Political Economy 98: 71–102.