Shiny new factories that roll out the most advanced technology, preferably without releasing many emissions. Many governments now seem to be pursuing this ideal image, with all kinds of industrial policies. Countries outdo each other with subsidies, favorable tax regimes and other incentives to attract or retain the most promising high-quality companies.
The Dutch outgoing cabinet recently allocated 1.7 billion euros for a plan to keep ASML and other companies in the chip sector in the Netherlands. And this week, the US Biden administration secured mega investments in chip production from Taiwan's TSMC, providing more than 6 billion euros in subsidies, plus 4.5 billion euros in favorable loans.
The International Monetary Fund speaks in its semi-annual report on public finances, the Fiscal Monitor, of a 'revival' of industrial policy. For a long time, especially in the West, the idea that the government should interfere as little as possible in business was dominant, but that time is over. For example, the Biden administration introduced the CHIPS Act (Creating Helpful Incentives to Produce Semiconductors) for the chip industry and the Inflation Reduction Act for climate technology. Europe has the Green Deal industrial plan, Japan adopted a 'New Direction for the Economy and Industrial Policy', and South Korea has the K-Chips Act. China has been pursuing a very active industrial policy with large-scale state support for some time.
The IMF's message to all those governments: be very cautious with that industrial policy. Profiting from 'specific sectors' is 'often very expensive' – and at a time when governments are already short on cash. Meanwhile, industry subsidies threaten to reinforce the trend of 'geoeconomic fragmentation' – the break-up of the global economy into rival blocs.
It is much better for the global economy, says the IMF, if governments use their scarce resources to stimulate innovation “broadly”, not just in sectors that they happen to consider important. Fundamental research in particular (where a possible application is not determined in advance) needs more public financing, the IMF believes.
'High cost'
The Fund sees with dismay how governments have rapidly expanded their industrial policy arsenal. IMF economists looked at the number of industrial policy measures, such as tax breaks for chip makers or subsidies for hydrogen projects, as part of the total of trade measures. Ten years ago that was 20 percent, now 60 percent.
The IMF will hold its annual spring meeting in Washington next week. With the Fiscal Monitor, the Fund is involved in a sensitive international political debate. The US and Europe have been accusing China of unfair competition with state subsidies for years, Europe in turn fears the appeal of the American Inflation Reduction Act to its 'own' companies.
This proliferation of industrial subsidies largely has a geopolitical background, the IMF notes. The IMF speaks of a pursuit of “economic security”: countries want to be less dependent on foreign supplies in strategic sectors, such as (sustainable) energy and chip technology.
The IMF, guardian of the global economy, seeks to transcend these national interests and raises the question: how can innovation and its spread be promoted in a way that benefits the whole world?
The IMF is indisputable that innovation needs to be given a major push. It is concerned about the stagnant growth of productivity in the world. 'Productivity' is the quantity of goods and services that can be produced with existing resources (labor, capital, natural resources). Productivity growth, driven by technological breakthroughs and increasing efficiency, has proven to be the source of prosperity in the longer term.
Concerns about productivity
Productivity growth is “essential,” says the IMF. Global government debts have risen to record levels. Meanwhile, the population is aging and climate policy requires large expenditures. To pay for all this, economic growth is necessary and productivity must increase, says the IMF.
In another report partially released on Wednesday – the mid-year forecasts for the global economy, the World Economic Outlook – the IMF predicts that global economic growth will be only 3 percent annually in 2030 – about percentage points below the average growth rate in the years 2000 to 2019 (the last year before the pandemic). “Ambitious steps” are needed to increase productivity, is the message from the IMF.
Productivity does not only depend on innovation: well-functioning labor markets and free trade, for example, are also important, because they ensure that labor and capital can find their way to companies efficiently. But in the long term, stimulating innovation is “crucial”, says the IMF.
However, industrial policy does not simply improve innovation (and therefore productivity), says the IMF. State aid often does not lead to greater efficiency or goes to 'sectors with political connections'. If new knowledge is developed with these subsidies, it often ignores countries that have no money for industrial policy.
History shows that industrial policy is “prone to policy mistakes,” the report says. The 'fifth generation' computer technology subsidized by Japan in the 1980s, intended to power artificial intelligence, died a silent death, as did France's Minitel, a proto-Internet from the same period. In the more successful examples of state aid, the IMF mainly mentions the undesirable side effects. The long-term state support for the European aircraft manufacturer Airbus led to trade disputes between the EU and the US over subsidies to the aircraft industry. The EU is currently not concerned about this: Airbus is now the global number one, and it is being cited as an example of how Europe can operate strategically more autonomously.
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However, the IMF, which focuses on free trade and free capital movements, is always wary of protectionism. In fact, the Fund only considers targeted state support by governments to companies to be defensible for climate purposes, because the “social benefits” are clear: reduction of CO2emissions. However, the IMF notes: state support for greening must meet strict conditions, for example that “discrimination” against new companies on the market is prevented.
Growth through research
How should innovation be stimulated? Governments are in danger of losing sight of where their subsidies have the greatest added value, the IMF believes. That is the public financing of fundamental research. This produces the most knowledge and innovation – and therefore the most productivity growth.
If rich countries increase their expenditure on research and development by 0.5 percent of GDP (they currently spend 1 percent on it) and focus mainly on basic research, this will increase their GDP by 2 percent in the long term. And that, says the IMF, will also improve the affordability of government debt in the long term. “This is how this policy pays for itself.”
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