Endowments, Specialization, and Policy Olivier Cadot and Yuliya Shakurova* Abstract The paper explores the relationship between industry shares in production and their determinants including factor endowments, technology, and government policies, in a GDP–function framework. We use a new international panel dataset on production and trade compiled by the World Bank.As an intermediate step we calculate Hicks-neutral productivity indices that vary across industries, time, and countries. We find that own-TFP is robustly associated with industry shares across time and countries and that, after correcting for these productivity differences, output shares are related to factor endowments (Rybczynski effects) in a plausible way. Once Rybczynski effects are controlled for, we find little evidence of demand-side policies (import tariffs) affecting the allocation of resources; we find, however, more role for supply-side policies as the relative size of capital-intensive industries is positively associated with infrastructure–capital endowments. 1. Introduction What determines a country’s production pattern across sectors? Trade theory directly suggests a number of potential determinants: factor endowments, demand-side policies (tariffs and subsidies), and supply-side policies (e.g. the provision of infrastructure and public capital). But then, which of these determinants have proved across time and countries to be robustly associated with cross-sectoral production patterns, and can they be influenced by policy? In a perfect world, production patterns would surely best be left for markets to determine. However, as noted by Rodrik (2007, pp. 2–3): “The market failures that provide a role for industrial policy are the bread-and-butter of development economists.They are widely perceived to be pervasive, even if systematic evidence is sketchy and hard to come by. Informational and political problems in administering industrial policy are legion—but in that respect too industrial policy is no different from many other areas of policy. Moreover, most governments do carry out various forms of industrial policy already, even if they call it by other names (‘export facilitation,’ ‘promotion of foreign investment,’ ‘free-trade zones,’ etc.). Con- sequently, it is far more productive for the discussion to focus on how industrial policy should be carried out than on whether it should be carried it out at all.” Rodrik’s paper is representative of a revival in academic and political interest in industrial policy. Our opening question is thus, from a policy perspective, one of *Cadot:The World Bank, University of Lausanne, Faculty of Business, CERDI, CEPR, and CEPREMAP, Internef-Dorigny, CH-1015 Lausanne, Switzerland. Tel: +41-21-692-34-63; Fax: +41-21-692-34-95; E-mail: ocadot@worldbank.org. Shakurova: University of Lausanne, Faculty of Business, Internef-Dorigny, CH-1015 Lausanne, Switzerland. E-mail: juliya.shakurova@unil.ch.This paper is part of a World Bank research project. We thank an anonymous referee, Alessandro Nicita, Claudio Sfreddo, Rafael Lalive, Jean Imbs, Pascal St-Amour, and participants in the Department of Economics Research Days, University of Lausanne, for useful suggestions. Special thanks to Claudio Sfreddo for his help in the calculation of the public infrastruc- ture index, and to Alessandro Nicita for his advice in the early stages of the paper. Review of International Economics, 18(5), 913–923, 2010 DOI:10.1111/j.1467-9396.2010.00916.x © 2010 Blackwell Publishing Ltd