The Power and Pitfalls of Industrial Policy: Evidence from China

I study the impacts of industrial policy on innovation and industrial development by deciphering the landmark Chinese industrial policy - the Strategic and Emerging Industries initiative (SEI), from 2010 to 2018. Using differences-in-differences methods with staggered adoption and city-industry level data, I find that the policy significantly boosts patent counts, firm turnover, and output in targeted sectors, though gains in innovation quality and employment remain subdued. Additionally, I identify inefficiency in China’s top-down approach, where local governments prioritize alignment with national priorities over local comparative advantages. Sectors targeted with a pre-existing innovation advantage see at least double the gains in innovation and output compared to those without, underscoring the path-dependent nature of innovation. These findings emphasize the importance of aligning industrial policy with local strengths to foster quality-based growth. While the SEI initiative demonstrates China's ability to drive numerical growth, it also reveals the challenge of fostering widespread, quality-driven upgrading. These insights offer broader lessons for other developing economies navigating similar transitions.