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Economic development is a process of structural transformation with continuous technological innovation and industrial upgrading, which increases labor productivity, and accompanied improvements in infrastructure and institution, which reduces transaction costs. The middle-income trap is a result of a middle-income country’s failure to have a faster labor productivity growth through technological innovation and industrial upgrading than high-income countries. Industrial policy is essential for the government of a middle-income country to prioritize the use of its limited resources to facilitate technological innovation and industrial upgrading by overcoming inherent externality and coordination issues in structural transformation. The industries in a middle-income country may be classified into five different types, depending on their distance to the global technology frontier: catching-up industries, leading-edge industries, comparative advantage-losing industries, short innovation cycle industries, and comparative advantage-defying strategic industries. Industrial policy should be designed accordingly.
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Justin Yifu Lin (2017) studied this question.
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