Industrial Policy: Why is it Criticized and is there a Role for it in the 2020s?

Amitrajeet A. Batabyal
3 min readDec 24, 2024

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Industrial policy has been practiced around the world for a long time. Even though economists acknowledge that there exist a narrow range of circumstances in which this kind of policy makes sense, generally speaking, the practitioners of the “dismal science” tend to have a dim view of the ability of governments to conduct this kind of policy successfully. Why? Five reasons follow.

First, consider the matter of government failure and inefficiency. One of the most significant criticisms of industrial policy is that governmental interventions can lead to inefficiencies. In other words, governments may lack the necessary information to pick “winners,” i.e., industries or firms that are most deserving of support. Second, consider what is often called “rent-seeking behavior.” This means that industrial policy can create opportunities for rent-seeking, where firms or industries lobby for favorable treatment or subsidies instead of competing on the merits of their products or services. Rent-seeking involves efforts to capture economic benefits through political means rather than through productive activities, leading to a misallocation of resources and fostering inefficiency.

Third, the use of industrial policy may lead to political capture and to cronyism. In other words, governments may be influenced by powerful interest groups or political actors who can channel resources toward certain industries or firms with political connections. This leads to cronyism, where businesses with political ties benefit disproportionately, regardless of their actual contribution to economic growth. Fourth, there is the issue of market distortions. Put differently, industrial policies often involve subsidies, tariffs, or other forms of protectionism, which can distort market signals. For example, protectionist policies might shield domestic industries from international competition, reducing their incentive to innovate and improve efficiency. These distortions can also lead to higher consumer prices, reduced competition, and slower economic growth in the long run.

Finally, there are many practical instances where industrial policy has simply failed. Examples include poorly executed state interventions in the 20th century, such as the Soviet Union’s centrally planned economy, or cases of poorly designed subsidies that led to inefficiencies as in the case of U.S. steel industry subsidies in the 1970s and 1980s. These failures reinforce the skepticism that many have about whether industrial policy can work effectively in practice.

The above arguments contra industrial policy have been around for quite some time. Therefore, to test their applicability in the 2020s, what is needed is credible empirical research that sheds light on the extent to which industrial policy is or is not useful in contemporary times. Fortunately, thought-provoking new research answers this question authoritatively.

This research begins by helpfully choosing to focus on the so-called textbook case for industrial policy. In other words, the research concentrates on the case where one or more sectors in an economy are subject to external economies of scale which means that there is a divergence between the marginal private and social costs of production.

To examine the actual usefulness and the relevance of this textbook case, the research first provides a so-called general equilibrium analysis in which optimal industrial policy and its welfare effects are described utilizing the notion of sector-level scale elasticities. Next, the research empirically estimates these elasticities using trade data for 61 nations and extant estimates of such elasticities in the literature. It is important to point out that the empirical analysis does show that there exist substantial economies of scale in manufacturing sectors. This would appear to suggest a potent role for industrial policy by governments.

However, when the theoretical and the empirical results are combined to ascertain the quantitative gains from industrial policy, it turns out that these gains are positive but they “are hardly transformative.” Specifically, the gains range from 1.08 percent of GDP to 4.06 percent of GDP. This result is best understood using the divergence between the marginal private and social costs of production I alluded to previously. It turns out that this divergence, though present, is too small to give rise to large gains from industrial policy, even in countries that are very open to trade.

The Inflation Reduction Act, the CHIPS and Science Act, and the Infrastructure Investment and Jobs Act are three key industrial policy initiatives put forth by the Biden administration. However well-intentioned they may be, will they yield significant gains for America? As Guy de Maupassant reminds us in a prominent short story, the answer right now would appear to be “Qui Sait?”

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Amitrajeet A. Batabyal
Amitrajeet A. Batabyal

Written by Amitrajeet A. Batabyal

Amitrajeet A. Batabyal is a Distinguished Professor, the Arthur J. Gosnell professor of economics, & the Interim Head of the Sustainability Department, at RIT

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