Endogenous Policy Reform: Learning versus Flexibility in Industrial Policy Design for Open Economics

This paper studies government support which targets industries capable of learning. Monitoring procedures are implemented to prevent rent-seekers from non-learning industries. But this involves bureaucratic red tape that reduces flexibility in response to world market shocks. The main thrust of this study is that, as an economy develops, the balance shifts endogenously between the need for bureaucratic monitoring and the desirability for flexibility. An optimal strategy may be to support learning, with a certain degree of bureaucracy at an early stage when necessary, but to liberalize the policy toward laissez faire, as the economy matures. The results appear be consistent with empirical evidences in Asian countries.