Industrial Policies in Production Networks

90 Pages Posted: 23 May 2017 Last revised: 9 Jul 2019

Date Written: September 14, 2018


Abstract Many developing countries adopt industrial policies favoring selected sectors. Is there an economic logic to this type of intervention? I analyze industrial policy when economic sectors form a production network via input-output linkages. Market imperfections generate distortionary effects that compound through backward demand linkages, causing upstream sectors to become the sink for imperfections and have the greatest 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, sectoral interventions' aggregate effects can be simply summarized, to first order, by the cross-sector covariance between my sufficient statistic and subsidy spending. My sufficient statistic predicts sectoral policies in South Korea in the 1970s and modern-day China, suggesting that sectoral interventions might have generated positive aggregate effects in these economies.

Keywords: Production Network, Misallocation, Development, Growth, Industrial Policies

JEL Classification: C67, O11, O25, O47

Suggested Citation

Liu, Ernest, Industrial Policies in Production Networks (September 14, 2018). Available at SSRN: or

Ernest Liu (Contact Author)

Princeton University ( email )

22 Chambers Street
Princeton, NJ 08544-0708
United States

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