Industrial Policy Is Not a Magic Cure for Slow Growth

IMF Blog, April 10, 2024

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Many countries are ramping up industrial policy to boost innovation in specific sectors amid security concerns; examples cited include the United States’ CHIPS and Science Act, the European Union’s Green Deal Industrial Plan, the New Direction on Economy and Industrial Policy in Japan, and the K-Chips Act in Korea, alongside longstanding policies in emerging market economies like China.
Industrial policy can drive innovation if done right, but it is not a magic bullet; well-designed fiscal policies that support innovation and technology diffusion more broadly, with emphasis on fundamental research, can lead to higher growth and accelerate the transition to a greener and more digital economy.
The blog is based on Chapter 2 of the April 2024 Fiscal Monitor.

Targeted sectors must generate measurable social benefits, such as lower carbon emissions or higher spillovers of knowledge to other sectors.
Policies must not discriminate against foreign firms.
The government must have strong capacity to administer and implement such a policy.

Most industrial policy relies heavily on costly subsidies or tax breaks, which can be detrimental for productivity and welfare if not effectively targeted.
Subsidies are frequently misdirected toward politically connected sectors.
Discriminating against foreign firms can trigger costly retaliation and is likely self-defeating because most countries rely on innovation done elsewhere.
Without transparency and focus on environmental objectives, subsidies to green innovation can impose large fiscal costs.
Protectionist measures and inward-looking policies can fragment global trade and slow the diffusion of technology.

Supporting sectors that generate strong knowledge spillovers to the domestic economy (example cited: semiconductor industry).
Driving green innovation where necessary technologies to reach net zero emissions do not yet exist — provided subsidies are transparent, focused on environmental objectives, and complemented by robust carbon pricing to minimize fiscal costs.

Recommended complementary mix:
- Public funding for fundamental research.
- Research and development grants for innovative start-ups.
- Tax incentives to encourage applied innovation across firms.
Quantified estimate: increasing spending on these policies by 0.5 percentage points of gross domestic product—or about 50 percent of the current level in OECD economies—could raise GDP by up to 2 percent for the average advanced economy.
Long-run fiscal implication: that level of spending on innovation could even reduce the debt-to-GDP ratio over the long term.
Design considerations:
- Grants are most useful if targeted to earlier stages of the innovation lifecycle.
- Tax incentives must be easy to access if they are to benefit more than just large established firms.
Fiscal constraint note: countries with limited fiscal space may need to reprioritize other spending and raise more revenue in the short term.

Larger productivity dividends can be obtained by promoting diffusion of technologies developed elsewhere.
Necessary complementary investments include human capital and strategic infrastructure to fully reap benefits of technology inflows.

Governments deploying industrial policies should:
- Invest in technical capacity.
- Recalibrate support as conditions change.
- Act in line with open and competitive markets to avoid wasteful spending and protectionism.
Closer international cooperation and greater exchange of knowledge are critical to accelerate green and digital transformations.
Inward-looking policies diminish global innovative potential and slow technology diffusion, especially to countries that need it most.

Source: Era Dabla-Norris, Daniel Garcia-Macia, Vitor Gaspar, Li Liu; April 10, 2024 (IMF blog based on Chapter 2 of the April 2024 Fiscal Monitor).