The comeback of industrial policy—and what it means for capital flows

It is thus more about the steering wheel rather than the accelerator, delivering direction rather than speed. Also, industrial policy tries to correct market failures, while economic reforms in recent decades have been more focused on government failures.

The renewed spread of industrial policy was till recently more a belief than an empirically established fact. That is now changing. For example, economists Reka Juhasz, Nathan J. Lane, Emily Oehlsen and Veronica C. Perez trained a large language model to trawl through government policy documents to measure the spread of industrial policy across the world.

They found that the number of industrial policy interventions went up by an astonishing 30-fold from 2010 to 2022. This includes broader national industrial policies as well as those targeted at specific firms.

Industrial policy is likely to grow in importance as the world economy fragments, thanks to the rise of protectionism. Rising geopolitical tensions will add to its attractiveness.

In an unstable world, major countries would want to build domestic capacity in strategic sectors, though hopefully not succumb to the hubris of trying to do everything at home.

Given its rising popularity, it is important to examine industrial policy through a critical lens. A good place to start is to learn from a tale of two carmakers.

The South Korean conglomerate Hyundai began life as an infrastructure company, but made a bold move into car production in the second half of the 1960s.

Nearly two decades later, the Malaysian government backed its own national car project to manufacture the Proton. The two initiatives had very different trajectories.

Why did Hyundai succeed while Proton struggled? There are several competing explanations, but one significant difference was that the Korean government forced Hyundai to prove its mettle in the export market to justify financial support, while the Malaysian government chose to swaddle Proton in a protectionist cover.

The Hyundai versus Proton tale can be read as one that highlights the potential and pitfalls of industrial policy. How government support should be tempered with market discipline is one of the eternal questions on industrial policy.

China is now the world leader in industrial policy. A new paper by three economists at the International Monetary Fund—Daniel Garcia-Macia, Siddharth Kothari and Yifan Tao—takes a close look at the inner wiring of Chinese industrial policy.

The headline result of the study is that China outspent other countries, with its outlays adding up to 4.4% of gross domestic product (GDP) in 2023. However, many of the other details that their research highlights are instructive for policymakers in other countries, including India.

China pursues industrial policy in four ways—cash subsidies to firms, tax benefits to specific industries, subsidized credit and cheap land. Cash subsidies are the biggest item in the Chinese industrial policy bill. Next come tax incentives.

These two account for most of the fiscal support to specific industrial activities. Subsidized credit and land are less important in the Chinese playbook.

As far as cash subsidies and corporate tax benefits go, the sectors that got most of Beijing’s largesse were semiconductors, technology hardware, automobiles, pharmaceuticals, materials and software services. Consumer industries were only minimally supported through industrial policy.

This approach largely aligns with the broader reality that China is busy moving up the value chain and making its mark in key intermediates as well as frontier technologies.

Recent Indian industrial policy is led by fiscal subsidies offered by production-linked incentive (PLI) schemes. Subsidized land is another incentive thrown in by state governments.

Unlike in China, India’s industrial policy sweep covers not just industries of strategic importance, but also consumer industries such as textiles, white goods and food processing. The most successful PLI scheme till now is the one for the assembly of mobile phones.

There has also been some initial impact of incentives for chip fabrication and design under the India Semiconductor Mission.

This is the second major Indian attempt at industrial policy. The earlier version was designed in the 1950s by a newly independent country trying to add strategic depth to its industrial sector in the midst of the Cold War. It was led by the public sector.

The focus was on import substitution rather than export growth. The Nehruvian gambit failed after an initial decade of success. So did similar experiments in other developing countries such as Brazil.

It must be recognized that industrial policy seeks to guide the allocation of capital among sectors. Economists will try to understand whether capital allocation guided by the government improves or diminishes growth in factor productivity.

Others will argue that risk mitigation requires a large country to make some important products within its borders. Efficiency is a secondary concern. The tension between these two approaches will always remain at the heart of industrial policy debates.