The return of industrial policies: Policy considerations in the current context

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Introduction; Industrial policies are back in vogue

1. Global economic crises over the past two decades, including dissatisfaction with globalization and shrinking manufacturing employment in OECD countries, supply chain disruptions during the pandemic, and geopolitical tensions have resulted in increasing government interventions to boost economic and social stability and have rekindled interest in industrial policies and trade protectionism. (pp. 8-10, Figure 1)

2. There is no commonly agreed definition of industrial policy; policies generally refer to government help to businesses to boost or reshape specific economic activity especially targeted at selected firms or types of firms based on their activity, technology, location, size or age; they can involve a mixture of financial and non-financial measures; they can also be accompanied by trade protectionist measures. (p. 8)
3. Industrial policies were popular in the aftermath of World War II when broad consensus prevailed that government support and multilateral arrangements were the best way to achieve post-war reconstruction and raise living standards; since the mid-1960s, industrial policies lost appeal as mainstream economics stressed distortions from state intervention and documented failures of industrial policies; industrial policies are again rising in prominence not only because of economic crises but because of climate change and environmental challenges, the digital transition, the perceived need to respond to China’s growing economic power that has used large-scale state intervention for decades, and the intertwining of national security with international economics and foreign policy objectives. (pp. 9-10)
4. The nature and focus of industrial policies have evolved over recent decades, with support becoming more focused on sectors important to national security and the environment and on technology and its dissemination, compared to previously prevailing top-down state intervention to promote national champions in specific manufacturing sectors. (p. 10)
5. Assessing the scope and scale of government interventions and their evolution is difficult given a lack of consensus on definitions and unwillingness to comprehensively report measures and their cost; evidence suggests that industrial policies are an important part of economic policies in advanced and emerging-market economies; the extent of government support varies substantially across sectors; the number of industrial policies has increased considerably over the past decade and is particularly high in advanced economies. (pp. 10-13, Figure 2)

   

Policy considerations

1. Motivations for industrial policies: Theoretical justifications for industrial policies is rooted in the existence of unpriced positive and negative externalities leading to a market failure and gap between private returns and social benefits; industrial policies help to narrow the gap; horizontal industrial policies intend to support broader goals such as growth and competitiveness; targeted industrial policies aim at specific sectors, industries, and technologies. (p. 13)
2. Industrial policy should be justified by efficiency and cost-benefit considerations: Not all market failures should be addressed by industrial policies – alternative policies may be more efficient; decisions to implement industrial policies should be based on a thorough and inclusive cost-benefit analysis focusing on effects over the longer term and distributional impact across firms, households, and taxpayers; comprehensive evaluations and assessments before and after implementation are challenging; industrial policies are context-dependent, making it difficult to draw policy generalizations from past experiences. (pp. 14 and 16)
3. Successful industrial policies can bring large benefits for domestic and global economies, by better aligning market outcomes with economic, social and environmental goals, sustained improvements in living standards, and raising employment in disadvantaged areas. (p. 14)
4. Policy costs include that direct financial incentives may not be enough to implement desired and sizeable change; governments will waste funds by paying for projects that would have happened without their help; market distortions and trade-offs with other policy objectives that negatively affect availability, prices, quality, and innovation of goods and services; the highest distortions result from measures that effectively limit competition and increase protectionism; fiscal costs of industrial policies must be financed, including through higher taxation and lower government spending; market distortions can result from import tariffs, local content requirements, subsidies that negatively affect producers in other countries, tit for tat policies adopted in retaliation for industrial policies, and conflicts with competition policies. (pp. 14-15)
5. Cost-benefit analysis of industrial policies should take into account that domestic spillovers could be more important in the longer term than direct effects, including positive and negative spillovers; should account for fiscal implications comprehensively; and consider that global spillovers could also matter given uncertainty about the balance of positive and negative global effects of domestic industrial policies. (pp. 16-17, Box 1)
6. Pros and cons of industrial policies differ across specific objectives: governments should intervene where existing market failures cannot be addressed solely by markets and other policies and where failures clearly imply large social, economic, and environmental costs; governments should avoid policies that are less likely to achieve objectives and are highly distortive; some objectives are less controversial than others. (p. 18)
7. Green industrial policies: arguments in favor include the huge social and economic costs of inaction and that meeting green transition goals is unlikely without government help due to multiple market failures; green industrial policies are more likely to be politically acceptable than policies that concentrate costs on polluters, though the economic incidence of financial incentives is difficult to predict and consumer effects can vary across income groups; policies are also likely to have international distributional consequences potentially helping advanced economies in the short run while undermining developing economies, though developing economies may benefit from lower costs in the long run. (pp. 18-19)
8. Justifications for industrial polices supporting green technology development are strong, given that development of new technologies is necessary to meet emissions targets; subsidizing consumption and production of green technologies has pros and cons, without a clear advantage for either approach given the push and pull of market forces; protectionist measures to achieve environmental objectives can be counter-productive, making the green transition longer, more expensive, and alienating key trade partners. (pp. 19-20)
9. National security motivated industrial polices: economic activity has always been intertwined with national security though in recent decades what is considered a national security risk has expanded to include situations when the unavailability of certain components or final products could threaten the economic, health, or military security of a country; it is difficult to quantify costs, benefits, and effectiveness of industrial policy targeted at national security; three approaches are possible:
   1. Maintain the status quo, avoiding the costs of preemptive action but risking high costs in the event of geopolitical conflict or war;
   2. Eliminate foreign trade exposure with the help of industrial and trade policy, insulating the economy from some risks but at very high costs and with low likelihood of success; or
   3. Choose an intermediate solution by focusing on selected critical products or sectors, the selection of which should be based on well-grounded analysis. (pp. 20-21)
10. Place-based industrial policies: Such policies seek to reshape the geographical distribution of industrial activity by encouraging the development of industry in particular places; policies could address inclusiveness, fairness, and/or equality objective to foster equitable economic development in countries with large regional disparities; costs include productivity performance; policies may be geared to highly-capital intensive sectors where employment gains could be moderate; protecting jobs in specific sectors can be very costly for consumers; fiscal support can also lead to inflationary effects on wages rather than employment gains. (pp. 21-22)
11. Which policy measures to use: Measures should be tailored to specific problems so identifying the main causes of market and coordination failures is crucial; governments can choose:
    1. Policies that provide incentives for economic growth and encompass different policy areas;
    2. Targeted measures involving economic incentives in the form of production, R&D and credit subsidies, loan guarantees, and innovation-oriented public procurement;
    3. Creating framework conditions to enable the most productive firms to grow; better regulatory frameworks reduce barriers to entry and fostering competitive environments.
    A comprehensive strategy is likely to be more effective in solving market failures than single measures; governments can also add conditions related to social and environmental goals to the provision of support to private businesses to enhance the alignment of policies and the efficacy of incentives in achieving stated policy objectives. (pp. 22-24)
12. Evidence-based design and implementation of industrial policies could minimize risks of failures but not eliminate them: Designing and implementing policies to maximize benefits and minimize costs is difficult because of imperfect knowledge. (p. 24)
13. Time limits on targeted measures can limit abuse and control costs; long-term commitments of government support provide sufficient time to incentivize change, for effective implementation, and to reduce uncertainty; government decision-making processes to select specific firms and technologies should be competitive, transparent, and avoid favoring incumbents or discouraging new entrants; sunset clauses, claw back provisions, and clear performance indicators can reduce risk of private capture by well-connected and resourced businesses; terminating government assistance for unsuccessful projects is essential for minimizing costs of industrial policies; the decision-making process should be clear and explicit; simple rules and efficient administration of aid are also important. (pp. 24-25)
14. Ex-post audits help discipline stakeholders and also are a tool for learning about what works in industrial policy formulation; useful evaluations should be a) clear about the objectives and policy rationale; b) in advance of implementation, a well-defined evaluation strategy should be prepared so parties ensure that the data necessary to conduct the evaluation is collected; c) evaluations should be objective and free of political influence; and d) with respect to technology development, costs or productivity targets could be established as part of determining whether objectives have been met. (p. 25)

Conclusion

The OECD economic policy paper provides a concise and informative analysis weighing the pros and cons of industrial policies in the current era, with a useful analysis and structure to evaluate industrial policies. It is essential reading for policymakers and lawmakers considering adopting industrial policies in their economies.

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External Resources

• Rethinking international rules on subsidies – Council on Foreign Relations
  A report on updating the WTO toolbox on subsidies.

• Modern industrial policy and the WTO – Peterson Institute for International Economics
  A report raising questions about the use of modern forms of industrial policy and WTO rules.

• New Industrial Policy Observatory – Global Trade Alert
  A database of "new industrial policy" measures undertaken since January 2023.

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