Services and Modern Industrial Policy

Is the iPhone an industrial product or a service? Since the iPhone is made of aluminum, plastic, and other materials, and is manufactured on a typical assembly line, many would argue it is an industrial product. But, since most of the iPhone’s added value is services, i.e. research and development, embedded software, branding, design, and distribution, many would claim it is essentially a service. From the user’s standpoint, the iPhone without software is worthless, and the same goes for software without physical equipment to access it. This seeming conceptual ambiguity highlights one of the hallmarks of modern industrial activity: the intimate combination of industry and services in a mutually dependent relationship for the creation of value, and the blurred line between the two.

However, it was not always this way. The economic history of countries such as England and the United States shows that, throughout the nineteenth century and the first half of the twentieth century, most of the steps in the production of a given good were completed in the factory itself, which helps explain the rapid expansion of industry’s share in GDP. But economic history also shows that the increasing relevance of industry was coupled with the introduction of new technologies and innovations and new operating models. The outsourcing of certain production stages was introduced, and much of what was traditionally part of industrial activity gradually became decentralized services provided by third parties, leading to a growing complementarity and functional interaction between industry and services that actually raised total value added, while reducing the relative share of manufacturing in GDP.

The current stage of industrial development in several advanced economies reflects such pattern: a modest industry, along with a high density of R+D laboratories, universities committed to industry development, advanced distribution services, brands, marketing, financial services, and many other specific services aimed at adding industrial value. In fact, in several sectors, the contribution of this rich ecosystem of services can be much greater than the contribution on the factory floor. The United States is a case in point. While manufacturing accounted for only 12% of GDP in 2021, industrial activity—including that ecosystem—was at least 2.5 times greater and accounted for no less than 66% of total private investments in R+D. And this, in turn, was one of the main factors behind the recovery of the U.S. economy after the 2008 financial crisis and in the post-pandemic phase. It is clear, therefore, that the industrial sector as a whole has a major influence on the fate of the U.S. economy.

Late industrializing countries, such as South Korea, have followed the same industrial development model. While industry had a high (26%) share of GDP in 2021, technologies, innovations and other services are increasingly determining the true influence of the industrial sector. As a result, Korean brands of technologically advanced products, such as vehicles, computer chips and electronics, are already competing globally and have even taken the lead in certain segments. In China, manufacturing accounts for 27.5% of GDP, but the influence of the industrial sector is increasingly determined by technological development, brands, distribution networks and other services. The share of manufacturing in the GDP of these two countries is expected to decline in the coming years, but the impact of industrial activity is also likely to expand.

This discussion seems relevant in a context where industrial policy is making a strong comeback into public policy. Even developed countries that until recently opposed industrial policies are now seeking to expand local manufacturing output, going as far as implementing interventionist and protectionist measures and generous subsidies. There are no shortage of examples. Consider the U.S. Inflation Reduction Act, the Chips and Science Act, Buy American, or Reshoring, all of which in the U.S. ; or consider the Green Deal Investment Plan, the Critical Materials Plan, the Next Generation EU, or the Made in Europe Partnership, all implemented by the European Union. These policies are expected to succeed in promoting greater industrial production, but the key will be the availability of an innovative and sophisticated industrial ecosystem.

Emerging countries are also vying for a greater industrial role. India, Indonesia, Mexico, Vietnam, Brazil, Costa Rica, Honduras, Chile and many others are following the same path. But can they compete with richer countries? The relatively modest financial capacity to provide fiscal support and the lack of a comparable industrial services ecosystem puts them at a disadvantage and limits some countries to merely hosting maquilas.

At this point, in order to compete and have a place in the sun in the global industry, countries will need to focus their efforts on developing technologies, innovations, logistics, brands and a host of other industrial services, as well as working on the various factors that enable industrialization of their comparative and competitive advantages. After all, that is where the best and most plausible opportunities for emerging countries can be found. In the case of Latin America, for instance, countries should consider the industrialization of agriculture, livestock, fisheries, mining, rare earths, forests, biodiversity and the bioeconomy, as well as industrialization through green and renewable energies and biofuels, as championed by the corporate strategy of powershoring, among others.

For a better chance of success, industrial policy in emerging countries will have to be pragmatic, aim at targets with a keen eye, and encourage the development of an industrial ecosystem as a key element for a solid, self-sustainable and competitive productive transformation.