Industrial policies in production networks by Ernest Liu published by SSRN (9/2018)
Many developing countries adopt industrial policies favoring selected sectors. Is there an economic logic to this type of interventions? I answer this question by characterizing industrial policy in production networks. Market imperfections compound through backward demand linkages, causing upstream sectors to be the sink of imperfections and have the largest size distortions. My key finding is that the distortion in sectoral size is a sufficient statistic for the social value of promoting that sector; thus, there is an incentive for a well-meaning government to subsidize upstream sectors. Furthermore, aggregate effects of sectoral interventions can be simply summarized by the cross-sector covariance between my sufficient statistic and policy spending. My sufficient statistic predicts sectoral policies in South Korea in the 1970s and in modern-day China, suggesting that sectoral interventions might have generated positive aggregate effects in these economies.
