Industrial policy - identifying causal effects

Following up on the industrial policy story, I have come across an excellent blog post that sets the bar for research in this field. John van Reenen writes on the VoxEU blog about a recent CEPR paper by himself and co-authors (Criscuolo et al. 2012) on industrial policy in the U.K.

To evaluate the impact of providing incentives or subsidies to firms is difficult, since such programmes might finance activities that the firm would have undertaken anyway. In addition, looking at what happened to recipients relative to non-recipients, does not tell you what would have happened in the absence of government support. In their paper  they try to identify the causal impact of a ‘Regional Selective Assistance’-programme in the U.K. This programme offers investment subsidies to firms in depressed areas on condition they “create or safeguard employment”. The beauty is that they are able to examine every grant and manufacturing plant over a 20-year period and the experimental variation comes from EU-wide rules changes about state aid laws.

Their find that the scheme was successful at increasing investment.

 Manufacturing employment rose and these jobs seemed to come from lower unemployment rather than being “stolen” from unaffected regions and firms. A 10% investment subsidy causes about a 7% increase in employment, with about half of this arising from growth in existing plants and half from higher net entry.

Government grants to smaller firms (fewer than 150 workers) were effective in increasing investment and employment, but money given to larger firms had effectively zero effect. An explanation is that grants help remove the financial constraints faced by smaller firms, whereas larger firms have deeper pockets.

A possible downside of the scheme was lower aggregate productivity as the grants tended to go to less productive firms and had no impact on improving their productivity.

In South Africa, research like this is limited by the availability of data. Work by myself and Marianne Matthee (forthcoming in JEFS) found that access to finance matters for productivity:

Firms that indicate that access to finance is a constraint to their operations are typically small and less established. They are not able to allow their clients to pay after delivery and they have to pay for their purchases before or on delivery. These firms also hold a smaller stock of inventory. The firms that are constrained by access to finance are less likely to own a generator or use own transport to make shipments. These firms are also less likely to pay for security or to provide formal training. They have lower capacity utilisation and are unlikely to be exporters or to introduce new products in response to competition. All this indicate that they may be more vulnerable to shocks and competition as well as being weaker contributors to employment creation and growth.

The SBP also produces interesting SME research, but at the moment there is still too much talk about industrial policy, subsidies, incentives and the importance of SMEs and too little analysis.