Picking Winners Is Difficult and Costly

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Industrial policy—government actions to assist industries deemed strategically important—is again central to policymakers’ toolkits amid green and digital transitions and growing economic insecurity.
Key recent policy examples and drivers:
- The US Inflation Reduction Act of 2021, offering unprecedented tax credits and subsidies to foster investment.
- China’s proactive policies supporting “strategic” sectors such as clean energy technologies and chip manufacturing.
- The European Green Deal as the EU response to US and China policy moves.
Historical context: industrial policy fell out of favor decades ago in advanced economies because of risks of subsidy races and trade wars; these concerns have reemerged with the revival of industrial policy.

Two causes of growing capital scarcity:
- Depressed global savings because of population aging—especially in advanced economies, but also in China, and to a lesser extent in other emerging markets.
- Increased capital demands to address decarbonization and digitalization challenges.
Transition-related capital issues:
- Stranded assets (mostly fossil fuel reserves that lost their value) and capital obsolescence from the move to greener energy.
- Developing economies’ pressing needs to enhance infrastructure and invest in human capital (for example, increasing electricity access).
Implication for real interest rates and fiscal constraints:
- The real interest rate, known as r-star—the neutral interest rate that equilibrates the economy in the long run—will likely rise after several decades of staying at very low levels.
- Combined with high levels of public debt, a higher real rate will impose strong financial constraints on advanced economies.
Capital coefficient and productivity:
- As industrial policy becomes mainstream in advanced economies, the capital coefficient—the ratio of the stock of capital to output—will rise, and productivity may decline.
- A waste of scarce capital will erode advanced economies’ net international investment position and impose burdens on future generations.

Main risk: wasting scarce capital through misallocation when capital is limited (investment mistakes harder to absorb than when capital is abundant).
Historical note: China’s three decades of abundant capital allowed many investment mistakes to be absorbed; that may not be replicable going forward.
Emerging examples of problematic outcomes:
- China: manufacturers, including of electric vehicles, facing bankruptcies amid overcapacity.
- United States: a large proportion of projects associated with the Inflation Reduction Act have been delayed.
- European Union: industrial policy on batteries for electric vehicles is faltering because of the (unexpected) drop in demand for such vehicles.
Developing economies’ vulnerabilities:
- As capital becomes scarcer and more expensive globally, higher debt in advanced economies may constrain government spending and occasion reductions in development aid capital transfers to poorer countries.
- Several major traditional donors, including the United Kingdom, have reduced aid commitments.
- Financing the energy transition for developing economies will be harder; countries face trade-offs between retiring hydrocarbon resources to meet net zero targets or using hydrocarbon resources to provide energy to their populations.

Recommendation: state clearly and precisely the objectives being pursued to avoid cluttering industrial policy programs with multiple, sometimes geopolitical, objectives that are less directly linked to economic logic or market-failure justification.
Recognize trade-offs:
- Trade-off between speed and effectiveness of public action associated with industrial policy, which could have harmful consequences for present and future generations.
- Need to balance geopolitical motivations and externalities linked to climate and the environment when justifying public intervention.
Governance prescription:
- The era of scarcity in global capital calls for stricter and more transparent governance of industrial policy.
- Favor reasoned actions by keeping trade-offs in mind and prioritizing clear, narrowly defined objectives that align with correcting identified market failures.

Source: Picking Winners Is Difficult and Costly. RABAH AREZKI and JEAN-PIERRE LANDAU. F&D Magazine, September 2024.