Between two coordination failures: automotive industrial policy in China with a comparison to Korea

Since 1985, China has attempted to re-structure its automotive industry through an industrial policy approach closely modelled 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. The size of the Chinese firm is small in a sector with well-known economy of scale (FOS) features and even the largest firm operates below minimum efficient scale. This article analyses the reasons why government in Korea could enforce EOS-enhancing policies in the 1970s and 1980s while the Chinese government, with similar policies, has not been able to do so. The argument is that the 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 less than a socially optimal level. This is the familiar form of market failure and is known as Coordination Failure 1 (CF1) in this article. The other is to overcome a coordination failure on the part of the firms to invest excessively. This is known as Coordination Failure 2 (CF2). CF2 is more costly to overcome than CF1 in institutional terms and China's divided and decentralized bureaucratic arrangements have made it difficult for government to overcome CF2.