Industrial policy's global rise: Benefits clouded by risks
There's a growing trend in industrial policy worldwide, characterized by government support for selected sectors or companies. Such interventionism can be justified when market competition fails and its outcomes require correction. However, industrial policy is often costly and ineffective, especially in developing countries.
The percentage of goods and services exports backed by governments as part of industrial policy is rapidly increasing. In 26 of almost 40 countries where the European Bank for Reconstruction and Development operates, industrial policy now accounts for an average of 45% of exports, compared to just 10% in 2010. In the USA and Germany, this percentage has already reached 90%.
This finding is part of the EBRD's flagship publication, the "Transition Report 2024," released Tuesday. The report focuses on the causes and effects of the increasing wave of interventionism.
The government will help when the market fails
Industrial policy, as outlined by the report's authors, includes any state action designed to influence the structure of the economy—either by supporting or protecting a selected sector from competition. Such policy instruments include tariffs, subsidies, tax reliefs, and regulatory actions, such as requirements for manufacturers to use local components. On the other hand, instruments like VAT or income tax reductions or reforms to facilitate business operations across the entire economy are not examples of industrial policy.
"These solutions can be effective and justified when they address evident and urgent market failures, such as climate change or environmental degradation. But the current effects of industrial policy are ambiguous when considering the benefits, costs, and consequences of mistakes," wrote Prof. Beata Javorcik, Chief Economist of the EBRD, in the foreword to the report.
Javorcik notes that with every market failure that state intervention addresses, there's an accompanying risk of government failure. "80 to 90% of industrial policy actions involve discrimination against foreign entities, which can distort the playing field and lead to tensions in international cooperation," explains Javorcik. The worst consequence of such a policy is that it often replaces the real reforms needed to maintain economic competitiveness.
The pandemic was a turning point
The previous peak in the popularity of economic interventionism occurred after World War II. At that time, it was intended to aid in rebuilding economies. Industrial policy fell out of favour with governments in the 1970s and 1980s. However, a resurgence has been observed in recent years. Why?
The report's authors highlight several causes. First, growing public support for interventionism and a greater role of the state in the economy can be linked to a series of crises in the global economy, as indicated in one of the previous EBRD reports.
Secondly, issues have emerged worldwide that the market seems unable to address. This includes the need to halt climate change without compromising energy and food security and boost economic innovation.
Thirdly, there's a trend towards concentration in many markets, meaning an increase in the share of the largest firms. These enterprises find it easier to persuade governments to support them. Politicians may feel that helping the largest domestic companies is acting in the whole economy's interest.
Fourthly, the largest economies, including the USA and China, have started using industrial policy instruments more willingly, convincing other countries' governments that they, too, cannot remain passive. Notable examples of industrial policy in the USA in recent years are the CHIPS and IRA acts, which provide financial support for semiconductor manufacturers and reduce inflation by supporting domestic production in the so-called green economy. Other developed economies, such as Canada and the EU, reacted to Washington's protectionist policies.
Poland is a regional leader in industrial policy
Economists from the EBRD note that since 2010, China and the USA have introduced the most industrial policy instruments, followed by Germany, Brazil, India, Italy, Japan, Russia, Canada, Spain, France, and the United Kingdom. Among the countries where the EBRD operates, the leaders are Turkey and Poland, followed by Greece, Hungary, and Romania.
Expenditures related to industrial policy surged during the Covid-19 pandemic. The report's authors calculate that in the EU countries where the EBRD operates, state aid for companies jumped from 0.8% of GDP to 1.5% of GDP. Later, it did not decrease and amounted to 1.6% of GDP in 2023. This amount doesn't include the costs of tax reliefs, only subsidies and preferential financing.
Effective industrial policy requires competence
When can industrial policy be effective? Economists from the EBRD explain that such actions should have a clearly defined goal. Without this, or if there are multiple goals, it's impossible to assess whether the industrial policy instruments have achieved the expected outcomes. Without such evaluation, it's difficult to determine when they should be phased out.
Unfortunately, the EBRD report shows that industrial policy increasingly rarely has one well-defined goal. More often, there are several, sometimes conflicting, goals. For example, a government may want to accelerate the green transformation of economies, support employment, and ensure supply chain security simultaneously.
The negative consequences of industrial policy are more likely in less developed countries, where problems with the rule of law and public sector quality are present. These are places where there is a greater temptation to use simple and cheap tools, but at the same time, the most disruptive to the market, such as direct export or import bans, discretionary licensing requirements for exporters or importers, and subsidies. Their consequence might be suboptimal allocation of labour and capital resources, leading to higher costs and prices and corruption.
Economists from the EBRD recommend that industrial policy—when necessary—should have a well-defined goal and timeframe. It should, as much as possible, enforce competition among entities that benefit from it rather than supporting pre-selected firms.
