Aggressive use of industrial policy by the world’s most powerful economies risks becoming an expensive mistake that could trigger a tit-for-tat subsidy war, the International Monetary Fund has said.
In a warning shot to governments around the world, the IMF said attempts to increase innovation only worked under certain limited conditions and were not a “magic cure” for slow growth.
Era Dabla-Norris, the deputy director of the IMF’s fiscal affairs department, said: “History shows that getting industrial policy right can be a tall order, and there are many cautionary tales of policy mistakes, high fiscal costs and negative spillovers to other countries.”
It comes as leading western governments adopt an increasingly interventionist approach to boosting economic growth, gradually turning away from a reliance on the private sector, low taxes and the light-touch regulation built up over the past four decades.
In a sign of increasing tensions over industrial policy, Beijing has accused the EU of protectionism after Brussels launched a subsidy investigation into Chinese wind turbine companies.
“China is highly concerned about the discriminatory measures taken by the European Union against Chinese companies and even industries,” the country’s foreign ministry spokesperson Mao Ning said.
The EU’s competition commissioner, Margrethe Vestager, announced an investigation on Tuesday into whether Chinese companies involved in wind farms across Europe may have benefited from support from Beijing.
While careful to avoid singling out any country for criticism, the IMF used a chapter from its half-yearly fiscal monitor to express scepticism about the benefits claimed for industrial strategies and urged rich countries to concentrate on support for underfunded basic research.
It said recent initiatives – such as the Chips Act and Inflation Reduction Act in the US, the Green Deal Industrial Plan in the EU, the New Direction on Economy and Industrial Policy in Japan, and the K-Chips Act in Korea – as well as longstanding policies in large emerging market economies such as China were alike in having a strong emphasis on innovation in specific sectors.
Most packages involve governments offering tax and subsidy incentives for investment in green and advanced technologies, including artificial intelligence and semiconductors.
Dabla-Norris said the resurgence in industrial policy was motivated by concerns about economic and energy security, and the hope that it would re-ignite productivity growth, which has been weak in many parts of the world since the global financial crisis of 2008.
Using industrial policy to promote innovation was only worth it if the benefits could be well identified and measured, and the subsidies were provided to sectors that generated higher knowledge spillovers to other sectors, Dabla-Norris said. Gains could be particularly high in the case of innovation that accelerated the development of green technologies to lower carbon emissions.
However, she feared activist government policies could lead to “misallocation of resources and capture by special interests”, because most approaches relied heavily on costly subsidies. “Potential gains could quickly run into sizeable losses,” she said.
“Further, we show that discriminating against foreign firms can actually prove self-defeating, as such policies can trigger costly retaliation in most countries. Even major advanced economies rely on innovation that is done elsewhere.”
The IMF said in technologically advanced economies, a more cost-effective way to increase innovation and growth was a mix of public funding for fundamental research, research and development grants for innovative startups, and tax incentives to encourage applied innovation across firms.
“We estimate that increasing spending on these policies by 0.5 percentage points of gross domestic product – or about 50% of the current level in OECD economies – could raise GDP by up to 2% for the average advanced economy. That level of spending on innovation could even reduce the debt-to-GDP ratio over the long term.”
