DP16534 The Long-Term Effects of Industrial Policy

Author(s): Jaedo Choi, Andrei A. Levchenko
Publication Date: September 2021
Keyword(s): Financial Frictions, industrial policy, learning-by-doing, Welfare
JEL(s): O14, O25
Programme Areas: International Trade and Regional Economics, Economic History, Macroeconomics and Growth
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=16534

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.