Image Source: Pexels

Industrial policy can be defined as government policies that seek to shift the sectoral structure of an economy: for example, toward a certain high-technology industry, or toward a manufacturing industry, or in a lower-income country away from a heavy production of raw materials and agricultural goods and toward a greater emphasis on processing those outputs. Tools for industrial policy can involve direct subsidies, indirect subsidies (like low-interest loans or building key infracture), subsidies based on export performance, reducing import competition via tariffs and other methods, reducing barriers to trade to make it cheaper to purchase key inputs and goods, rules requiring domestic content in production of certain goods, direct government purchases of goods, and others. As one might expect, such policies have sometimes been successful, and sometimes have resulted in pouring resources down a rat hole.

A group of IMF economists–Sandra Baquie, Yueling Huang, Florence Jaumotte, Jaden Kim, Rafael Machado Parente, and Samuel Pienknagura–have published a Staff Discussion Note attempting to summarize some lessons in “Industrial Policies: Handle with Care” (IMF, SDN/2025/002, March 2025). Here are a few of their themes that caught my eye.

The standard examples cited as success stories for industrial policy tend to be countries from East Asia: Japan, Korea, Taiwan, China. The standard examples cited as failures of industrial policy are often countries from Latin America. One intriguing distinction here is that the success stories were outward-focused, requiring that industries meet export targets in the global economy to receive subsidies, while the failures often involved import substitution, in which imports were blocked to support domestic consumption for domestic use. The IMF economists write:

The debate around the effectiveness of IPs [industrial policies] has centered around two somewhat opposing narratives. On the negative side, there is the experience of Latin American countries with import-substitution, which, after two decades of favorable economic performance between the 1950s and the 1960s, have struggled to achieve high-productivity growth. On the positive side, there is the experience of Asian economies, such as Hong Kong SAR, Japan, the Republic of Korea, Singapore, and Taiwan Province of China, which focused on export-led growth and provided a blueprint for proponents of IPs. The divergent paths of Latin American and Asian economies have led many observers to stress the importance of design. For example, Cherif and Hasanov (2019) contrast the limitations of IPs focused on the development of domestic markets through import protection, which was the Latin American model, with the virtuous cycle fostered by the export-driven IP model pursued in Asia.

Another theme is that if one compares broad-based “structural” policies to more targeted “industrial” policies, the structural policies often have substantially larger and longer-lasting effects. Indeed, structural reforms may be a precondition for industrial policies to succeed. the IMF economists write:

Structural reforms have, on average, much larger effects than IPs [industrial policies], pointing to their fundamental role. IPs are accompanied by smaller economic benefits than “horizontal policies” focused on lowering corruption, improving governance and enhancing access to credit. Even when IPs may be desirable, horizontal policies are key. IPs are more effective in countries with better institutions, business environment, and financial market conditions, and a more educated workforce. Good institutions limit the capture of IPs by interest groups and facilitate their successful implementation. A strong business environment eases the flow of factors of production to targeted, fast-growing, firms, and pushes them to remain competitive. Efficient financial markets allow targeted firms to get a double boost to unlocking their potential, as IP support can be combined with private credit to seize profitable projects.

Industrial policies that reduce trade barriers tend to produce greater gains than import tariffs that limit trade. The IMF discussion note says:

Relatedly, trade-liberalizing IPs—those that reduce trade restrictions—are associated with higher firm productivity and value added in the medium term, with negligible change in the stock of capital. … An additional liberalizing policy is associated with improved medium-term performance of firms: 1.6 percent higher productivity, 1.2 percent higher value added, 0.8 percent more payroll (a proxy for wages and employment), and 0.4 percent more capital stock although the latter is not statistically significant (Figure 8, panel 3). The positive association between liberalizing trade conditions and firm productivity and value added relates to a long-standing literature on how lower trade barriers can strengthen competition in the liberalized sectors, inducing firms to leverage economies of scale, improve efficiency, and innovate (Helpman and Krugman 1985; Melitz 2003, Aghion and others 2005). Differently from export incentives and domestic subsidies, which are targeted in nature, liberalizing trade barriers yield a uniform impact across firms within the targeted sector. The results are in line with the finding that industrial subsidies targeting high-externality sectors yield smaller welfare gains compared to trade liberalizing measures such as broad-based tariff reductions (Bartelme and others 2019).

Lowering import barriers also favors technological transfers in the medium and long term. Although well-targeted protectionist IPs may temporarily boost received technological transfers, lifting trade-restricting policies unlocks larger and potentially longer improvements. Lifting an additional import barrier increases the number of received patent applications by 5 percent on average after four years …

Finally, industrial policies aren’t free, but impose both monetary and nonmonetary costs. The IMF economists write:

On the fiscal front, IP [industrial policy] expenditures in the 2019–21 period in a sample of OECD countries amounted to about 1.4 percent of GDP (Criscuolo and others 2023). Thus, in the context of high debt levels, IPs can limit governments’ ability to save and/or redeploy resources to tackle other challenges. IPs can also affect sectors or firms that are not targeted, through the reallocation of sales or resources to the supported entities. This action may not be welfare enhancing if IPs are not well targeted and this reallocation harms more productive sectors or firms. Moreover, the current geoeconomic landscape adds to the complexity. IPs can lead to cross-border spillovers, raising the risk of retaliation by other countries, which can ultimately weaken the multilateral trading system and worsen geoeconomic fragmentation. This, in turn, can also limit global welfare by stifling innovation incentives and the flow of new technologies across countries.

From my own perspective, arguments in favor of industrial policy often devolve into a list of injustices purportedly faced by US firms in global markets. The injustices sometimes seem real to me; other times, not so much. Also, I am perplexed by anyone who expects global markets to reflect concerns of justice–especiallly if these concerns somehow lead to cutting off support for the trade dispute resolution mechanisms of the World Trade Organization.

But perhaps more to the point, the arguments over what is “fair” in global trade often seem to me a way of blaming others while failing to tackle domestic policy issues. For example, the US economy has real challenges with K-12 education and worker training, with its oversized budget deficits and growing levels of government debt, with keeping its research and development at the cutting edge of technological progress, with rules and regulations that give small pressure groups a way to stifle both good and arguably harmful development, and with other issues as well.

More By This Author: