Home ›› 30 Mar 2023 ›› Opinion
Industrial policy is gaining momentum in many countries, with some economists pointing to China’s model as a success. In a world facing challenges such as the Covid-19 aftermath, vaccine nationalism, global supply-chain instability, net zero transitions, and geopolitical competition, there is renewed debate about the role of industrial policy and government support for firms and industries deemed strategically important.
People are questioning whether we can trust the free market, and there are concerns that countries are losing their innovation edge. National security hawks also worry about relying on adversaries for critical resources such as semiconductors and pharmaceuticals.
In the US, industrial policy is no longer a taboo subject. There is bipartisan support for the Creating Helpful Incentives to Produce Semiconductors and Science Act (CHIPS Act), which aims to revitalize the US semiconductor industry. More than 90 percent of advanced chips, crucial for defense and artificial intelligence (AI), come from Taiwan Province of China—which raises concerns about US industry vulnerability in case of an attack. To address such risks, the US government is allocating $39 billion in funding from the $280 billion CHIPS Act to support the development of advanced semiconductor manufacturing capability. The Biden administration’s industrial policy is far-reaching, and at least two semiconductor manufacturing clusters are planned by 2030. Funding recipients also face extensive conditions, such as a 10-year ban on expanding advanced chip capacity in China and a commitment to affordable childcare. These policies are part of the administration’s broader approach to industrial policy, which also includes $370 billion in subsidies for clean energy in the Inflation Reduction Act.
Meanwhile, Japan is providing subsidies worth more than $500 million to 57 companies to encourage them to invest domestically—as part of its efforts to reduce reliance on China. Similarly, the European Union is scaling up its industrial policy—including by setting aside €160 billion of its COVID-19 recovery fund for digital innovations such as chips, batteries, and climate adaptation. In response to massive subsidies in the US Inflation Reduction Act, Italy’s economy minister recently called for a common EU approach to support competitiveness and protect strategic production.
Focus on national champions
“Industrial policy” refers to government efforts to shape the economy by targeting specific industries, firms, or economic activities. This is achieved through a range of tools such as subsidies, tax incentives, infrastructure development, protective regulations, and research and development support.
When implementing industrial policy as part of their growth strategy, countries are often faced with competing objectives, such as securing sustainable economic growth, maintaining financial and fiscal stability, and establishing “national champions.”
Establishing national champions is often a distinct objective of a nation’s growth strategy. Several considerations underpin this objective, including: (i) enhancing national security by promoting self-sufficiency in key industries, (ii) supporting job-rich and inclusive growth, (iii) revitalizing left-behind communities, and (iv) the voter optics associated with reviving the manufacturing sector.
Various countries have promoted specific firms or industries as national champions—such as semiconductors in Taiwan Province of China, renewable energy in Germany, and aerospace in France. This approach aims to create globally competitive companies, ensuring economic growth and security.
Although the use of industrial policy to establish national champions has been successful in some cases, it remains controversial. Economists worry that picking winners and losers can lead to market distortions and inefficient allocation of resources. Despite the concerns, the revival of industrial policy shows no signs of slowing down.
In a world of increasing economic nationalism and geopolitical tensions, establishing national champions is likely to remain an important policy objective for governments seeking to advance their national interests. In this context, the Growth Strategy Trilemma framework I develop below can guide policymakers in striking a balance among economic growth, stability, and national champion objectives.
The framework highlights the challenges policymakers face in balancing the competing demands of economic growth, financial and fiscal stability, and the establishment of national champions. Pursuing any two of these objectives comes at the cost of partially sacrificing the third, making it a trilemma.
Governments that support safe champions (Strategy A) prioritize financial and fiscal stability along with support for safe national champions. This strategy often emphasizes national security, prudence, and resilience over the potential benefits of a more aggressive growth strategy.
The strategy of supporting bold champions (Strategy B) emphasizes economic growth and the selection of risk-taking national champions. However, this approach may result in less attention to stability concerns. This could result from greater risk-taking activity or less focus on efficiency and governance—leading to potential costs to the financial system and resulting in fiscal costs. Still, governments that pursue this strategy are willing to accept a higher risk of instability to pursue higher growth.
Finally, the fair-market capitalism approach (Strategy C) prioritizes stability along with economic growth—without a focus on national champions. Instead, the emphasis is on supporting a dynamic market economy along with free entry and ensuring that businesses operate in a fair and competitive marketplace.
Fair-market capitalism also offers a different path to achieving national security goals than the industrial policy approach. Instead of each country promoting national champions, the approach encourages a diversified global supply chain based on open and fair trade, thus avoiding an economic arms race. This approach can lead to greater efficiency and innovation in the long run while mitigating risks of supply-chain disruptions through diversification and international cooperation.
These trade-offs are not simply about choosing one objective over the other, but rather striking a balance among the three (on a continuum). The best approach for any government will depend on a range of contextual factors, including the state of the economy, the financial system’s health, electoral pressures in the political system, and the geopolitical environment.
Nevertheless, efficiency gains may make it sensible to move toward the fair-market capitalism strategy. Yet governments often succumb to the temptation of establishing national champions. Why? A key factor could be the psychology of national leadership and the pressures on government leaders when choosing economic policies.
Imagine for a moment the life of a country leader. You have been elected to lead your country and are now responsible for decisions that will impact the well-being of millions of people. You must balance the competing demands of economic growth, national security, financial and fiscal stability, and social and environmental concerns. The stakes are high, and the pressure can be overwhelming.
A significant pressure you face as a country leader is the need to deliver economic growth. Achieving adequate growth can be essential for maintaining your political power, providing jobs, and ensuring the stability of your society. Without sustained growth, you may face mounting unemployment and social discontent, endangering your political tenure.
This pressure can manifest as growth anxiety. Clinical psychology studies show that anxiety causes people to become fixated on immediate concerns, often at the expense of long-term goals. In the context of economic growth, leaders may experience similar anxieties that cause them to prioritize short-term performance and quick wins to relieve their anxiety and demonstrate progress. This can lead to a narrow focus on particular industries or companies perceived as providing immediate growth—and disregard for the potential stability risks and downsides of this approach.
IMF Blog
