Constructing a Ladder for Growth: Policy, Markets, and Industrial Upgrading in China

Indigenous firms in developing countries with large domestic markets have unique advantages: the low end provides “natural” protection from foreign competition, while higher-end segments provide incentives for foreign firms to localize activities and develop channels for future capability building. Paradoxically, in their eagerness to support development efforts of local firms, states often nullify these advantages and limit the opportunities and capabilities that local firms can leverage in the upgrading process. Using the case studies of three large industrial sectors in China that faced similar prospects but had widely different outcomes, this paper develops a framework for understanding how policy shapes the growth and segmentation of markets, and thus the opportunity for industrial upgrading of indigenous firms. The cases show how restrictive demand- and supply-side policies often inadvertently limited the opportunities for upgrading through their effect on the availability of know-how, inputs, and resources required for industrial upgrading (the supply side), and through their effect on the incentives for upgrading (the demand side). Given that each segment is a crucial rung on the development ladder, industrial upgrading efforts stall when state policy inadvertently knocks out rungs on the development ladder.