TY - JOUR AU - Aghion,Philippe AU - Dewatripont,Mathias AU - Du,Luosha AU - Harrison,Ann AU - Legros,Patrick TI - Industrial Policy and Competition JF - National Bureau of Economic Research Working Paper Series VL - No. 18048 PY - 2012 Y2 - May 2012 UR - http://www.nber.org/papers/w18048 L1 - http://www.nber.org/papers/w18048.pdf N1 - Author contact info: Philippe Aghion Department of Economics Harvard University 1805 Cambridge St Cambridge, MA 02138 Tel: 617/495-6675 Fax: 617/495-4341 E-Mail: paghion@fas.harvard.edu Mathias Dewatripont Universite Libre de Bruxelles E-Mail: mathias.dewatripont@ulb.ac.be Luosha Du Department of Agricultural and Resource Economics UC Berkeley Giannini Hall Berkeley, California 94720 E-Mail: luosha@berkeley.edu Ann Harrison The Wharton School University of Pennsylvania 2016 Steinberg Hall-Dietrich Hall 3620 Locust Walk Philadelphia, PA 19104-6370 Tel: 215 746 3132 E-Mail: annh@wharton.upenn.edu Patrick Legros ECARES, Universite Libre de Bruxelles CP114 50 avenue Franklin Roosevelt 1050 Brussels BELGIUM E-Mail: plegros@ulb.ac.be AB - This paper argues that sectoral policy aimed at targeting production activities to one particular sector, can enhance growth and efficiency if it made competition-friendly. First, we develop a model in which two firms can operate either in the same (higher growth) sector or in different sectors. To escape competition, firms can either innovate vertically or differentiate by chosing a different sector from its competitor. By forcing firms to operate in the same sector, sectoral policy induces them to innovate "vertically" rather than differentiate in order to escape competition with the other firm. The model predicts that sectoral targeting enhances average growth and productivity more when competition is more intense within a sector and when competition is preserved by the policy. In the second part of the paper, we test these predictions using a panel of medium and large Chinese enterprises for the period 1998 through 2007. Our empirical results suggest that if subsidies are allocated to competitive sectors (as measured by the Lerner index) and allocated in such a way as to preserve or increase competition, then the net impacts of subsidies, tax holidays, and tariffs on total factor productivity levels or growth become positive and significant. We address the potential endogeneity of targeting and competition by using variations in targeting across Chinese cities that are exogenous to the individual firm. ER -