Rather it is about the public sector playing a leading role in identifying key

Rather it is about the public sector playing a

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about expanding technology frontiers to create new industries. Rather, it is about the public sector playing a leading role in identifying key development bottlenecks and addressing coordination failures. Finance is also an important factor. In less developed economies, financial markets are underdeveloped. Financial institutions that specialize in intermediating risks associated with large-scale projects do not exist. Thus, the government needs to mobilize domestic and external financial resources. As an economy matures, the nature of industrial policy changes. Production technologies become more sophisticated and the promotion of new industries moves into uncharted territory. Industrial policy has to confront high-return, high-risk tradeoffs that are too much for the public sector to take on alone. Furthermore, as an economy matures the balance of expertise gradually shifts from the public to the private sector. Therefore, it is natural that decisions about developing new products or sectors—often known as “picking winners”—is increasingly left to private firms. Political economy is also a factor. Industrial policy is unfair by nature as some areas of society benefit more than others. This inherent unfairness becomes less widely accepted as a society becomes more democratic. Also, as an economy develops, foreign competitors will not be as forgiving of government subsidy support for certain sectors. Therefore, the role of government in industrial policy tends to be more indirect in advanced economies.
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xii Executive Summary Indirect industrial policy A common misconception is that governments in advanced economies no longer pursue industrial policies. In fact, many advanced economies rely on “indirect industrial policy” by selecting and supporting industries through private financial markets. The government broadly defines the favored industries and announces incentives for private financing. The role of private financial institutions is to find candidates to support. The government adjusts the level of incentives to assume a minority or majority share of the guarantee depending on the risk involved. Good examples include the Multiannual Program for Enterprises and Entrepreneurship (MAP) under the EU’s Lisbon Strategy; various credit guarantee programs of the European Investment Fund (EIF); and the small and medium-sized enterprises (SMEs) onlending programs of Germany’s national development bank, KfW. The benefits of indirect industrial policy are numerous. Risks can be shared between the public and private sectors. The government can leverage the private sector’s deeper knowledge in selecting potential winners. Moreover, it is an effective way of minimizing the moral hazard problem. One of the practical difficulties of traditional industrial policy is that governments have difficulties withdrawing assistance to firms once extended. But with indirect industrial policy, private financial institutions, not the government, interact directly with firms and can withdraw their support, if
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