Ndustrial P Olicies in P Roduction N Etworks

Many developing countries adopt industrial policies that push resources towards selected economic sectors. How should countries choose which sectors to promote? I answer this question by characterizing optimal industrial policy in production networks embedded with market imperfections. My key finding is that effects of market imperfections accumulate through backward demand linkages, thereby generating aggregate sales distortions that are largest in the most upstream sectors. The distortion in sectoral sales is a sufficient statistic for the ratio between social and private marginal product of sectoral inputs; therefore, there is an incentive for a well-meaning government to subsidize upstream sectors. My sufficient statistic predicts the sectors targeted by government interventions in South Korea in the 1970s and in modernday China. JEL Codes: C67, O11, O25, O47 Word Count: 12,758 *Previous circulated under title “Industrial Policies and Economic Development”. I am indebted to Daron Acemoglu and Abhijit Banerjee for their guidance and support throughout this project. I thank Marios Angeletos, David Atkin, Sandeep Baliga, David Baqaee, Arnaud Costinot, Esther Duflo, Yan Ji, Nobu Kiyotaki, Pete Klenow, David Laibson, Nathaniel Lane, Pooya Molavi, Ben Moll, Dilip Mookherjee, Dani Rodrik, Gerard Roland, Alp Simsek, Andrei Shleifer, Ludwig Straub, Tavneet Suri, Linh Tô, Pengfei Wang, Shang-Jin Wei, David Weil, Ivan Werning, Heiwai Tang, Rob Townsend, Venky Venkateswaran, Daniel Xu, Hanzhe Zhang, Xiaodong Zhu, Fabrizio Zilibotti, and especially Chad Jones, Daniel Green, Atif Mian, Nancy Qian, Jesse Shapiro, and Aleh Tsyvinski, as well as seminar participants at MIT, Harvard, BU, Rochester, HKUST, JHU-SAIS, Brown, Kellogg MEDS, NBER-China meeting, Stanford SITE, and Bank of Canada-University of Toronto conference for helpful comments. †Princeton University. Email: [email protected]. Address: 214 Julis Rabinowitz Bldg, Princeton NJ 08544.