EBRD warns its economies to take care with industrial policies

• Industrial policies have become more widespread in both advanced economies and emerging markets
• The EBRD says emerging market economies pursuing industrial policies face higher risks
• Policymakers should clearly define industrial policy objectives and a hierarchy of goals

The global resurgence of industrial policies - state-led strategic interventions designed to reshape an economy's production structure - can yield positive results but need to be designed and implemented with tactical precision, the European Bank for Reconstruction and Development (EBRD) said today.

The Bank's latest Transition Report, entitled "Navigating Industrial Policy", sheds light on industrial policies across the EBRD regions and beyond, citing their mixed track record and presenting key principles for improving their success rate, while also highlighting the nuanced complexities of executing them effectively.

Governments are increasingly using strategic interventions, the flagship EBRD report says, to address pressing market failures such as climate change, to build on growing domestic support for policy intervention and to respond to the actions of large, advanced economies.

However, while industrial policies have potential, the report warns that they come with significant risks, especially in lower-income economies with weaker administrative capacity. Export bans, quotas and licensing requirements - common tools used in emerging markets due to their ease of implementation - can inadvertently increase costs for local producers and lead to the misallocation of labour.

"For emerging economies wanting to scale up the use of industrial policies, swift learning and getting the details right are critical. Missteps can lead to wasted public resources and introduce economic distortions, which will place heavy strain on already burdened public finances and adversely affect growth," said EBRD Chief Economist Beata Javorcik.

She added: "Making an industrial policy a success is easier said than done. Clearly articulating the goals of each policy, establishing a hierarchy of objectives, incorporating an evaluation mechanism and setting an end date are key."

A central theme of the new report is the challenge of balancing multiple and potentially clashing objectives within industrial policy frameworks. For instance, the goal of accelerating the transition to a green economy may not sit easily with protecting jobs or securing supply chains. Unless governments properly coordinate and prioritise their objectives, these industrial policies can cancel each other out and create economic distortions.

The report shows that 80 to 90 per cent of industrial policies favour domestic interests and discriminate again foreign ones, straining multilateral cooperation. Most policies tend to have multiple objectives and relatively few have an expiration date.

The publication also documents structural changes that have taken place in the EBRD regions. The growth of the services sector and the digital revolution have contributed to transforming the economic landscape in EBRD countries of operation. Several post-communist EBRD economies have become leaders in information technology exports, but others need to improve their infrastructure, skills and institutions in order to compete. Liberalising service trade and creating targeted industrial policies can support this shift, but only if strong economic foundations are in place.

Place-based industrial policies, such as the creation of special economic zones (SEZs), continue to proliferate globally, with more than 1,100 SEZs established in EBRD economies by 2020. These zones aim to attract investment, stimulate growth and reduce regional income inequalities.

While some SEZs have brought strong economic outcomes, the report notes that predicting their success remains difficult. Experiences vary significantly, with success depending on factors such as proximity to key infrastructure and the strength of local governance.

The new research also points out the rise of direct state support for private-sector firms in EBRD economies. Direct state assistance takes various forms, including in-kind and financial grants, production and interest-payment subsidies, loans, loan guarantees, tax reliefs and equity capital injections. However, this assistance is rarely tailored to the specific characteristics of the firms it targets, such as their growth potential and capacity to innovate.

Despite the promise of industrial policies to tackle critical challenges in emerging markets, the report shows that their success is not guaranteed. With less room for error, emerging economies must proceed cautiously, learning quickly from past mistakes.

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