Discussion Paper Details

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Title: The Long-Term Effects of Industrial Policy

Author(s): Jaedo Choi and Andrei A. Levchenko

Publication Date: September 2021

Keyword(s): Financial Frictions, industrial policy, learning-by-doing and Welfare

Programme Area(s): Economic History, International Trade and Regional Economics and Macroeconomics and Growth

Abstract: This paper provides causal evidence of the impact of industrial policy on firms' long-term performance and quantifies industrial policy's long-term welfare effects. Using a natural experiment and unique historical data during the Heavy and Chemical Industry (HCI) Drive in South Korea, we find large and persistent effects of firm-level subsidies on firm size. Subsidized firms are larger than those never subsidized even 30 years after subsidies ended. Motivated by this empirical finding, we build a quantitative heterogeneous firm model that rationalizes these persistent effects through a combination of learning-by-doing (LBD) and financial frictions that hinder firms from internalizing LBD. The model is calibrated to firm-level micro data, and its key parameters are disciplined with the econometric estimates. Cost-benefit analysis implies that the industrial policy generated larger benefits than costs. If the industrial policy had not been implemented, South Korea's welfare would have been 22-31% lower, depending on how long-lived are the productivity benefits of LBD. Between one-half and two-thirds of the total welfare difference comes from the long-term effects of the policy.

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Bibliographic Reference

Choi, J and Levchenko, A. 2021. 'The Long-Term Effects of Industrial Policy'. London, Centre for Economic Policy Research.