Trade, Foreign Investment, and Industrial Policy

During the last three decades, developing countries have made enormous strides in opening up their protected domestic markets to international trade and foreign investment. Yet most countries have not simply opened up their markets. They have also instituted a range of policies to encourage exports, attract foreign direct investment(FDI), promote innovation, and favor some industries over others. This leads to the following question: is openness to trade and FDI alone sufficient to achieve high growth rates in developing countries? If harnessing the gains from globalization requires additional policies, can we identify them? While some types of complementary policies, such as building roads and ports, are not controversial, others are. Bhagwati's suggestion to "attract foreign funds" implies tilting incentives in favor of foreign investors, which means abandoning policy neutrality. Our goal in this chapter is to explore the popular but controversial idea that developing countries benefit from abandoning policy neutrality vis-a-vis trade, FDI and resource allocation across industries.