Working Paper: NBER ID: w4779
Authors: Douglas Holtz-Eakin; Mary E. Lovely
Abstract: There has been an increased interest in the efficacy of industrial policy. We show that policy design for vertically-related industries hinges on the nature of market interactions as well as technological linkages. Using a model in which final-good producers realize productivity gains from increasing domestic specialization of intermediate processes, we find no theoretical basis for presuming that an imperfectly competitive intermediates sector restricts output below the optimal level or that the market produces too many varieties. The direction of distortion depends on the relationship between the extent of the external economy and the market power of individual intermediates producers. Optimal corrective policies require two instruments: an output subsidy and a lump-sum tax or subsidy. If only one instrument is available, it may be optimal to tax instead of subsidize the externality-generating activity.
Keywords: Industrial Policy; Market Structure; External Economies; Optimal Policy
JEL Codes: L13; O31; O38
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| technological linkages + market interactions (O36) | optimal policy outcomes (D78) |
| external scale economies + market power of intermediates (D40) | market failure in producing varieties of intermediate goods (D43) |
| optimal policy response (E63) | correction of market distortions (D41) |
| external economies generated by additional varieties > market power rents (F12) | optimal lumpsum policy (tax or subsidy) (H23) |