The IMF warms up to industrial policy, but with caveats

Industrial policy is back around the world. There is no better sign of this than the renewed attention given to subsidies by supporters of market liberalism such as the International Monetary Fund (IMF), which has historically been very skeptical of them.

Times are changing and the IMF’s Fiscal Monitor published earlier this month documented this in detail. Policy makers are increasingly turning to subsidies to achieve a variety of goals. The Fiscal Monitor documented the proliferation of industrial policy and, above all, offered a partial endorsement. The report also illustrates how economists’ views on industrial policy are evolving and where disagreement still exists.

What is the IMF approved version of industrial policy? In short, the IMF cautiously endorsed sectoral interventions as a way to promote innovation, but remains skeptical of measures that hinder free trade.

The IMF’s case for industrial policy starts from the recognition that innovation does not occur under ideal market conditions. New ideas and inventions have positive effects (externalities), which means that the market, left to its own devices, does not provide enough innovation.

This opens the door to policies such as research grants or tax credits for R&D that subsidize new research and inventions. These economy-wide measures are known as sector-neutral or horizontal industrial policy, and tend to have more acceptance among economists. But the IMF’s Fiscal Monitor went further, explaining when and why vertical or sectoral industrial policies can also be worthwhile. The key, according to IMF researchers, is to target sectors that have particularly high spillovers where a breakthrough would improve productivity in many other areas or where there are other unresolved market failures. They cite clean energy and health as examples.

This Fiscal Monitor shows that well-designed fiscal policies to stimulate innovation and technology diffusion can generate faster productivity and economic growth across countries, the report concludes.

The IMF endorsement comes with many caveats, which the researchers summarize:

They also note that larger, less open economies like the United States benefit more from these policies because they capture more of the benefits of innovation subsidies.

The IMF is not the only international organization that recognizes the case for industrial policy. OECD researchers published an extensive and largely positive assessment in 2022.

However, the IMF’s version of industrial policy is not necessarily the most fashionable. Above all, the Fiscal Monitor warns that policies of discrimination against foreign companies can prove self-destructive and trigger costly retaliation. In a paper published in January, IMF researchers found that two-thirds of industrial policies enacted by 2023 were trade-distorting. So while in theory the IMF may be warming up to industrial policy, in practice it remains skeptical.

Walter Frick is editor-in-chief of the Atlantic Council’s Center for Geoeconomics

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Wednesday, October 18, 2023

Design an industrial and commercial policy between the US and the EU

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Erik Brattberg, Frances Burwell, Jrn Fleck, Charles Lichfield, Zach Meyers, James Batchik and Emma Nix

Both sides of the Atlantic face the geopolitical need to adapt trade and industrial policies to be fit for purpose in an increasingly competitive world. To avoid competition between Washington and Brussels, policymakers must recognize the priorities of each side and commit to greater cooperation to serve the transatlantic economic relationship, not expand it.

Image: Tesla Gigafactory under construction, Austin, Texas, January 4, 2021.