Between Two Coordination Failures: Automotive Industrial Policy in China with a Comparison to Korea

Abstract

For twelve years now, China has attempted to develop and to consolidate its automotive industry through an industrial policy approach closely modeled on that of Korean government in the 1970s. While the growth of the automotive industry has been impressive, government's consolidation attempt has been a failure. This article argues and uses the example of Korea to show that success of automotive industrial policy (AIP) requires two necessary components. One is to overcome a coordination failure on the part of the firms to invest at a socially optimal level. This is the familiar form of market failure and is known as Coordination Failure I (CFI) in this article. The other is to overcome a coordination failure on the part of the firms to restrain entry into the automotive sector, This is known as Coordination Failure 2 (CF2). CF2 is more costly to overcome than CFI in political terms and this asymmetric cost structure explains much of automotive developments in China.