The Great Return of Vertical Industrial Policy

Faÿçal Hafied, Andrés Ortega

5 mins - 18 de Mayo de 2023, 07:00

After 40 years of market deregulation, that is, of blind and blissful belief that free trade will spread prosperity and liberal democracy around the world, a rupture is taking place in economic policies. Its most spectacular manifestation is the return of 'vertical industrial policy' i.e., discretionary public support for a sector or 'national (or European, in the case of the EU) industrial champions', through the allocation of generous subsidies, targeted tax breaks, and public procurement. Outwardly, this policy entails protectionist, or at least mercantilist measures.

This top-down industrial policy is being implemented throughout the developed world. In China, the CCP is recentralizing the private sector. In 2020, it promoted a directive to strengthen the party’s presence on boards of directors. At the same time, Xi Jinping’s regime has tightened its grip on the domestic digital giants, while re-signaling he needs them in the innovation race with the US. The aim is to align them with the party’s economic goals, especially in the race for dominance in artificial intelligence. Public mega-funds called 'guidance funds' are providing money to private Chinese venture capital funds. Finally, the party continues to make extensive use of state planning.

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The United States, not only not to lag behind, but to stay ahead, have promoted the Chips and Science Act, which will allocate $52 billion to the semiconductor sector. The Inflation Reduction Act will massively fund the country’s ambitious industrial decarbonization goal earmarking $342 billion for clean energy (wind, green hydrogen, biofuels). The Buy American Act, which allows to reserve subsidies to companies based in the United States, was recently reinforced by two presidential Executive Orders one issued by Trump, the other by Biden, while protectionism (on general import and advanced technology export towards China) has intensified since 2018.

The European Union, long the good pupil of the liberal class, is also experiencing a transformation. Important Projects of Common Interest (IPCEIs), which allow public subsidies of cutting-edge technologies, are moving away from the strict orthodoxy of limiting state aid, while criticism of EU competition policy is growing from Berlin to Paris over the Commission’s rejection of the Alstom-Siemens merger, which was to create the 'Airbus of the High-Speed Train'. This was followed by a Franco-German manifesto calling for the establishment of a 'European industrial policy'. Last February, the European Investment Bank (EIB) announced the creation of a European fund to support future domestic technology champions with an investment capacity of €3.5 billion (Spain will contribute €1 billion). In addition, a regulation restricting access to the European market for foreign companies subsidized in their own country will be soon enacted. Finally, in response to the U.S. Inflation Reduction Act, current discussions around the Net Zero Industry Act aim to have 40% of energy transition technologies produced in the EU.

What explains such a sudden change in the West? There are three possible answers:

First, China’s brutal, state-led economic and technological recovery seems to rehabilitate the validity of top-down industrial policy. Chinese national R&D spending has surpassed that of the EU since 2014 and now reaches 85% of that of the US. The country has moved from 43rd in 2010 to 11th in 2022 in the World Innovation Index (WIPO). China seems to be taking an inventory of the Western model, promoting the rule of law (fight against corruption, strengthening competition policy, improving intellectual property, etc.), an essential function of economic growth, but also applying a narrow economic dirigisme while reinforcing state control over civil society. Beijing uses its soft power to export this model.

Secondly, the competition between the US and China for world leadership has largely crystallized around technology, which became an instrument of sovereignty. The race to the technological frontier increases the fixed costs of R&D, which encourages States to massively subsidize their national champions or pre-selected sectors. The 'France 2030' plan will allocate €54 billion over five years to technology-intensive sectors chosen by the government, such as green hydrogen or hybrid vehicles. Germany has announced the launch of a public deep tech fund, endowed with one billion euros, which will focus especially on climate transition technologies. Finally, the Spanish PERTEs also aim at the technological upgrade of several sectors, supported by funds coming from Brussels and drawn from the Fondo de Recuperación, Transformación y Resiliencia. At the same time, the country has strengthened control of non-EU foreign investments.

Finally, the West is experiencing disenchantment with what in the early 2000s was called “happy globalization” (Alain Minc). Free trade, in addition to boosting economic growth in Asia, destroyed manufacturing jobs in the West and fostered a divide between the “creative class” (Richard Florida) and low-skilled workers, the “dispossessed” (Christophe Guilluy) that conducted to Donald Trump’s victory in 2016, with his 'America First' credo ('Buy American', with Biden) and the multiplication of protectionist measures that followed. These conceptions are also spreading in Europe.

Is this return of discretionary industrial policy to be celebrated? Economists disagree. On the one hand, it seems effective in terms of the recovery of “infant industries” (Paul Krugman) in emerging countries, but on the other hand, it exacerbates protectionism, since it leads to reshoring, a bottleneck factor, and to industrial concentration, the combined effects of which increase inflation. Moreover, some studies show that vertical industrial policies are relevant for incentivizing incremental innovation in mature technologies, but less so for spurring breakthrough innovation, the heart of tomorrow’s growth. In any case, there is no doubt that the times and modalities of industrial policy have changed.

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