NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Trade, Foreign Investment, and Industrial Policy for Developing Countries

Ann Harrison, Andrés Rodríguez-Clare

NBER Working Paper No. 15261
Issued in August 2009
NBER Program(s):   ITI

In this paper we explore the popular but controversial idea that developing countries benefit from abandoning policy neutrality vis-a-vis trade, FDI and resource allocation across industries. Are developing countries justified in imposing tariffs, subsidies, and tax breaks that imply distortions beyond the ones associated with optimal taxes or revenue constraints? We refer to this set of government interventions as "industrial policy". We explore the theoretical foundation for industrial policy and then review the related empirical literature. We follow this with a broader look at the empirical work on the relationship between trade and FDI and growth. In this review, we find little evidence that countries benefit from "hard" interventions that distort prices to deal with Marshallian externalities, learning-by-exporting, and knowledge spillovers from FDI. We discuss an alternative set of "soft" industrial policies that deal directly with the coordination failures that may arise within the sectors or clusters where the country has a comparative advantage.

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Document Object Identifier (DOI): 10.3386/w15261

Published: Ann Harrison, Andrés Rodríguez-Clare (2010), Trade, Foreign Investment, and Industrial Policy for Developing Countries, Handbook of Development Economics, Vol 5: 4039-4214. [Harrison - Published Paper]

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