Global rise in industrial policy fuels export growth battles

The percentage of goods and services exported that are supported by governments under industrial policy is growing rapidly. In 26 out 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 U.S. and Germany, this percentage has already reached 90%.

This conclusion comes from Tuesday's publication of this year's edition of the EBRD's flagship report, "Transition Report 2024. " The publication is dedicated to the causes and effects of the rising wave of interventionism.

As explained by the report's authors, industrial policy involves state actions aimed at influencing the economy's structure by supporting or protecting selected industries from competition. Tools of such policy include tariffs, subsidies, tax breaks, and regulatory actions, such as requirements for producers to use local components. In contrast, tools that support the entire economy, like reductions in VAT or PIT or reforms that facilitate business activities, are not examples of industrial policy.

"These solutions can be effective and justified when they address clear and urgent cases of market failure, such as climate change or environmental degradation. But the results of applying industrial policy to date are ambiguous when considering the benefits, costs, and potential for mistakes," wrote Prof. Beata Javorcik, chief economist of the EBRD, in the report's foreword.

Javorcik points out that each instance of market failure addressed by state intervention carries the risk of government failure. "80 to 90% of industrial policy actions involve discrimination against foreign entities, which may distort the playing field and lead to tensions in international cooperation," explains Javorcik. However, the most severe consequence of such a policy is that it often replaces the real reforms needed to maintain an economy's competitiveness.

The previous peak of economic interventionism occurred after World War II. At that time, it aimed to support economic reconstruction. Industrial policy fell out of favor among ruling powers in the 1970s and 1980s. But in recent years, its renaissance has been noticeable. Why?

The report's authors point to several reasons. First, there is growing public support for interventionism and a larger role of the state in the economy, which can be linked to a series of global economic crises, as highlighted by previous EBRD reports.

Second, problems have emerged that seem beyond the market's capability to handle effectively. These primarily concern the need to curb climate change without compromising energy and food security and the desire to increase economic innovativeness.

Third, many markets show a trend toward concentration, meaning an increase in the share of the largest companies. Such enterprises can more easily persuade governments to provide support, especially since politicians may believe that helping the largest national companies benefits the entire economy.

Fourth, the largest economies, including the U.S. and China, have become more inclined to use industrial policy tools, convincing other governments that they cannot afford to remain passive. The most prominent recent examples of industrial policy in the U.S. are the CHIPS Act, which provides financial support for semiconductor manufacturers, and the Inflation Reduction Act, which aims to curb inflation by supporting domestic production in the so-called green economy. Other developed economies, such as Canada and the EU, have reacted to Washington's policies, viewing them as protectionist.

Economists from the EBRD estimate that since 2010, China and the U.S. have introduced the most industrial policy measures, 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, closely followed by Greece, Hungary, and Romania.

Expenditures related to industrial policy surged during the COVID-19 pandemic. According to the report's authors, in EU countries where the EBRD operates, state aid for companies jumped from 0.8% of GDP to 1.5% of GDP. However, it did not decrease afterward, reaching 1.6% of GDP in 2023. This figure does not include the costs of tax breaks, only subsidies and preferential financing.

When can industrial policy be effective? Economists from the EBRD explain that such actions should have a clearly defined goal. Without clear objectives, or when there are multiple goals, it is impossible to assess whether the instruments of industrial policy have achieved the expected results. Without such evaluation, it is difficult to determine when they should be phased out.

Unfortunately, the EBRD report shows multiple, sometimes conflicting objectives increasingly drive industrial policy. For example, governments may want to accelerate economies' green transformation while supporting employment and ensuring supply chain security.

Negative consequences of industrial policy appear more frequently in less developed countries, which struggle with the rule of law and the quality of the public sector. These countries are more tempted to use the simplest and cheapest tools to implement, which most disrupt market functioning—such as direct export or import bans, arbitrary licensing requirements for exporters or importers, and subsidies. The result can be a suboptimal allocation of labor and capital resources, leading to increased costs and prices and corruption.

Economists from the EBRD recommend that industrial policy—when necessary—should have a well-defined goal and duration. It should also, as much as possible, foster competition among the entities that benefit from it rather than support preselected companies.