The Industrial Policy Trap: Why Most Countries Fail at Picking Winners

Exploring why industrial policy succeeds in only a handful of countries while failing elsewhere, the political dynamics that determine success or failure, and lessons for current US efforts in semiconductors and clean energy.

Key Takeaways

• Industrial policy means government intervention to bolster specific manufacturing sectors rather than general economic management
• Only four countries achieved consensus success: Korea, Taiwan, Japan, and France, while most others failed despite similar approaches
• The key challenge is disciplining subsidized firms through export requirements rather than allowing them to remain protected domestically
• Political capture by business elites explains most failures, as subsidized firms resist transitioning to competitive export markets
• Korea succeeded partly through historical luck of partnering with Japanese firms seeking to outsource lower-end manufacturing
• Democracy provides advantages over authoritarianism for industrial policy by enabling public accountability for taxpayer money
• The US lacks administrative capacity for effective industrial policy despite having existing manufacturing sectors to build upon
• China's recent approach involves using domestic competition to identify winners before providing massive state support for exports
• State capacity and bureaucratic competence matter more for success than political system type (democratic vs authoritarian)

Timeline Overview

• 00:00–08:30 — US Industrial Policy Context: Introduction to current concerns about CHIPS Act and clean energy investments, questioning whether massive spending will create competitive industries
• 08:30–18:15 — Defining Industrial Policy: Vivek Chibber explains industrial policy as specific government intervention to support particular manufacturing sectors, distinct from general state economic involvement
• 18:15–28:45 — Success Stories and Comparative Advantage: Historical examples of Korea, Taiwan, Japan, and France successfully moving beyond comparative advantage theory to build high-value manufacturing
• 28:45–38:20 — The Discipline Problem: Why subsidized firms resist export competition and how successful countries managed to force competitiveness through performance requirements
• 38:20–48:30 — Political Economy of Failure: How business elites capture governments to maintain protective subsidies without performance, explaining widespread industrial policy failures
• 48:30–58:15 — Korea's Lucky Break: Historical accident of Japanese partnership enabled Korean firms to access US markets through established Japanese networks and technology transfer
• 58:15–01:08:45 — Capital and State Capacity: Role of development banks in providing cheap credit and current US challenges with administrative capacity for industrial policy implementation
• 01:08:45–01:18:30 — Democracy vs Authoritarianism: Why democratic systems may actually advantage industrial policy through public accountability mechanisms for taxpayer-funded subsidies
• 01:18:30–01:25:00 — Reform Recommendations: Proposals for transparent, democratically accountable industrial policy including worker representation and competitive bidding processes

Defining Industrial Policy: More Than General Government Intervention

Industrial policy represents a specific form of state economic intervention focused on directing investment flows toward particular manufacturing sectors, distinct from broader government economic management.

• Industrial policy involves government action "when States intervene to bolster particular sectors of the manufacturing base of the economy rather than affecting the general structure the general the proportion between manufacturing and Agriculture"
• This specificity distinguishes industrial policy from general state intervention since "states are involved in economies all the time they affect it sectoral balance they affect its place in the global economy they affect trade flows without necessarily however being forms of industrial policy"
• The core mechanism involves "selecting winners when you say that sector or that plant or that area of manufacturing should be supported and change therefore the balance of investment flows from one sector to the other"
• Traditional economic theory suggested countries should follow "comparative advantage" by specializing in activities where they perform relatively best, typically meaning "poor countries should specialize in labor intensive Industries or agriculture"
• Industrial policy explicitly rejects comparative advantage by attempting to move countries into "high-end consumer goods automobiles even capital goods like steel heavy chemical" rather than remaining locked in low-value sectors
• The challenge becomes creating space for domestic industries to develop capabilities before facing global competition from established producers like Ford and GM in automobiles

The Success Stories: Moving Beyond Comparative Advantage

Only four countries achieved widespread recognition for successful industrial policy: Korea, Taiwan, Japan, and France, demonstrating that success requires both protection and performance requirements.

• Successful countries implemented "import substitution which means you're trying to substitute for imports your domestic Goods that means tariffs and protection" while simultaneously providing "incentives to domestic producers to promise them essentially you won't take a loss"
• The dual approach created protected domestic markets where "foreign Goods become more expensive and therefore our Goods have some breathing space because when you start making a good for the first time it's going to cost a little bit more to the consumer"
• Government subsidies and credit made it "attractive for investors to move into these lines because they're high-risk" by reducing the financial barriers to entering sophisticated manufacturing
• Success enabled countries to move from "just specializing in cheap clothes and shoes and things like that they start producing more high-end goods and these are Goods that produce more profits have higher rates of growth"
• The transformation allowed countries to "Propel that country into the ranks of first middle-income countries and then later High income countries on the back of a dynamic and high-end manufacturing sector"
• France's post-war success through the late 1960s demonstrates that European countries could also implement effective industrial policy despite different political and economic contexts than East Asia

The Discipline Problem: Why Subsidies Create Complacency

The fundamental challenge of industrial policy lies in preventing subsidized firms from becoming complacent monopolies that consume public resources without improving productivity or competitiveness.

• Protection and subsidies "takes away what is best about the market" because "why do capitalists why do firms worry about productivity" stems from competitive pressure where "if they don't worry about productivity they're going to go under"
• Import substitution "take away that competitive mechanism and substitute government oversight" creating artificial monopolies that eliminate the market discipline that drives innovation
• The danger emerges because "you're essentially giving people monopolies you're giving them Monopoly over certain sectors insulating them from competition and you're giving them free profits when they have free profits why are they going to innovate"
• Most countries experienced the first outcome where "you deploy industrial policy and these artificial monopolies and you end up getting a fat CAD industrial sector that's gobbling up national resources but not delivering a lot in terms of productivity and growth"
• Successful countries found ways to "complement the subsidies with some kind of enforced competitive pressures" by requiring firms to "succeed in export markets take this money invest it and now don't just produce your Hyundai or Kia for the Home Market we want to see you selling it in the US in Europe"
• Export performance provided "an unambiguous metric by which you could say whether or not you're succeeding in picking these winners and whether or not they're in fact winners"

Political Capture: Why Most Countries Failed to Transition

The political economy dynamics of industrial policy explain why most countries failed to transition from protected domestic production to competitive export markets, as subsidized businesses captured governments to maintain privileges.

• By the late 1960s and early 1970s, development institutions including "the World Bank the IMF all the Breton Woods institutions but also the economic Commission on Latin America" understood the need to "promote exports in our economies to push these guys into competitive regions"
• Despite widespread recognition that export promotion was necessary, "it only happened in two or three countries in country after country after country you found them hanging on to the subsidies and the general import substitution long after everyone realized" it was self-defeating
• The political trap emerged because "all the economists assumed was a government in a state that's essentially free to do and powerful enough to do whatever it wants to tell firms to do whatever it wants them to do"
• Reality proved different since "in any modern industrial capitalist economy these firms who you're trying to push into exports are also the people with the most political power the most political influence they have the lobbyists they have all the money they fund elections"
• The fundamental contradiction arose when governments tried telling subsidized firms to "give up that free money and go into essentially shark infested waters and Country after country what most of them said was nah we're not going to do it actually we like it just the way it is"
• Business influence over politics meant "since we fund all the politicians whoever gets into Power we're going to make sure they keep plowing this money towards us" creating systematic resistance to performance requirements

Korea's Historical Luck: Japanese Partnership and Market Access

Korea's industrial policy success resulted partly from historical circumstances that provided safe entry into competitive export markets through Japanese corporate partnerships and established trade networks.

• Korea's transition to export promotion in the "mid to late 60s" occurred because it "entered into these Partnerships with Japanese firms who already had a foothold in the highly competitive and thereby dangerous American Market"
• Japanese companies possessed crucial assets including "established sales networks banking facilities they knew the market they knew they had customer relations" in lower-end manufacturing exports
• The partnership worked because "Japan wanted to do is essentially move out of these lines into more high-end lines of high-end consumer products and capital goods" creating space for Korean entry
• Japanese firms could "have joint ventures with Korean firms they come in we shephered them into selling shirts and shoes" while making money through "the bank loans that enables them to open up the factories in Korea"
• This arrangement allowed Japanese companies to profit from "two ends instead of" by moving into higher-end goods while earning loan income from Korean manufacturing operations
• The contrast with India proved crucial because "British and American firms explicitly forbade their Indian Partners in India to sell in export markets because they wanted to keep them for themselves" limiting Indian export opportunities
• Korean success involved "switching from one line to the other so if you know textiles is a hierarchical sector so if they put up barriers on the lowest end of textiles you move up the value chain" demonstrating adaptive capabilities

State Capacity and Administrative Challenges

Effective industrial policy requires sophisticated bureaucratic capabilities that most countries, including the contemporary United States, struggle to develop and maintain.

• Development banks played crucial roles by providing "artificially low and cheap credit to local firms to lower their entry barriers into these competitive markets" through "nationalized banking systems the main function of which was to collect large pools of domestic savings and then bundle them up and funnel them towards investors"
• Early industrial policy required countries to engage in "State Building" because governments could perform basic functions like "raising taxes to some extent providing tariffs to some extent and policing and some kind of credit" but lacked capacity for "institutionalized relationship with leading firms monitor their activities and then impose some kind of discipline"
• The United States faces similar capacity constraints because "outside of Defense the American government really doesn't have a lot of what you call it administrative capacity" needed for "deploy resources negotiate with firms and hold them accountable"
• Current implementation challenges appear in how "two and a half years after the Act was passed a lot of the money just still sitting there it hasn't really gotten to the firm that were being targeted" due to insufficient "absorptive capacity"
• The US situation differs from developing countries because it involves "not trying to create sectors out of whole cloth" since "there is already a chips manufacturing sector in this country there's already EV manufacturing" requiring acceleration rather than creation
• This existing industrial base means "you're not trying to get industrialists drag them Kicking and Screaming into new sectors they're already kind of inclined towards to go into those sectors you simply trying to accelerate the flow of investment rather than redirect it altogether"

Democracy vs Authoritarianism: Accountability Advantages

Contrary to conventional wisdom, democratic political systems may provide advantages for industrial policy implementation through public accountability mechanisms that authoritarian systems lack.

• Historical evidence shows mixed results since among "the four cases that everyone says are shining examples of successful industrial policy it's a wash it's two and two" with Korea and Taiwan being authoritarian while Japan and France remained democratic
• Chibber argues "actually authoritarianism is the obstacle and democracy is an advantage" because industrial policy involves "taking public money tax money citizens money and you're giving it to people for their private benefits which is industrialists"
• Democratic systems enable mobilization of "public opinion behind the project to say look we promise all of you citizenry higher growth because we're going to have this policy of enhancing and improving domestic industrial manufacturing capacity"
• Transparency becomes possible in democracies where governments can "provide subsidies for National Industrial Development but these guys are taking your money and listen we're going to make sure on your behalf we're going to make sure they use it wisely"
• Authoritarian systems disadvantage accountability because "Democratic rights have been extinguished who relies most on Democratic rights the rich or the poor it's the poor because the rich always have access to what politicians are doing"
• Dictatorships provide "the government greater power over the poor because the wealthy always have power so in fact in a dictatorship you should see more difficulty in disciplining in industrialists because now everything happens behind closed doors"

China's Market-Based Selection Model

China's recent industrial policy approach offers an alternative model that uses domestic competition to identify promising firms before providing massive state support for global expansion.

• After Mao's death "the whole planning apparatus and system in China kind of fell apart for about 15 or 18 years and it's really in the early 2000 that it gets going again" with market-oriented industrial policy
• The Chinese approach involves using "government finances as kind of venture capital" where "they direct the state bureaucrats to give cheap loans to a fairly large number of firms and then they kind of wait and see who survives in domestic competition"
• Selection occurs through market testing where authorities "see all right who are the top three because how can they do that the domestic Market has grown to the point where it's intens competitive so you see who is winning the domestic battle"
• Once winners emerge, the government acts to "catch them in their infancy and you say we're going to bet on these guys" rather than creating firms "from Whole cloth" as earlier industrial policy attempted
• This approach differs from traditional models because "China lets them do this sink or swim for a few years and then when firms have built up a certain degree of competence shown that they're capable of managing the Market they start plowing money into them"
• Success appears evident since Chinese firms are "killing it so much that that's behind the American drive to protect themselves that's why you won't see a Chinese EV because I think they would just clobber all the American EVS"

Reform Recommendations: Transparency and Worker Participation

Effective industrial policy reform requires transparency, democratic accountability, and stakeholder participation beyond traditional business-government relationships.

• Chibber recommends "a agency dedicated to targeting particular sectors and fostering their growth but it should be a agency that is staffed not just by bankers and industrialists but also by representatives of trade unions and the people the employees"
• Worker participation matters because "they have a direct stake in how well those firms do" and "if you harness the energy of the employees alongside that of the industrialists you're going to have a dynamism in the sectors"
• Current problems stem from "such a one-sidedness to investment decisions that industrialists are able to make their profits and make their Investments without any regard for how private benefits that they're getting from those Investments redounds"
• Transparency becomes essential to "make the American state more transparent in how it's intervening in the economy because it's always doing it there's no such thing as a laay fair State even within the neoliberal era"
• Accountability should extend to "both the investors and to the workers because the investors also lose from all the sweetheart deals that occur behind the curtain in the defense sector make the bidding more competitive"
• The political imperative stems from the reality that "around 80% of the people in the United States feel that their government and their economy is captured by a narrow Elite that's unaccountable to them" requiring policies that create "new kinds of jobs where they feel respected engaged and they feel they have a stake"

Conclusion

Industrial policy's track record reveals that technical economic knowledge about the need for export discipline and competitive pressure has been available for decades, yet most countries failed to implement effective policies due to political capture by business elites. The handful of successes—Korea, Taiwan, Japan, and France—achieved results through different combinations of historical luck, state capacity, and political arrangements that enabled governments to maintain discipline over subsidized firms. Current US industrial policy faces similar challenges of building administrative capacity while preventing political capture, but democratic systems may actually provide advantages through transparency and public accountability mechanisms.

China's recent approach of using domestic market competition to identify winners before providing state support offers a potentially more sustainable model than traditional top-down picking of champions. Ultimately, successful industrial policy requires not just economic expertise but political arrangements that ensure public investments serve public purposes rather than becoming permanent subsidies for private interests.

Practical Implications

• For Policymakers: Focus on building administrative capacity and transparency mechanisms before launching large-scale industrial policy programs to avoid money sitting unused or being captured by private interests
• For Business Leaders: Understand that sustainable industrial policy requires demonstrating export competitiveness rather than relying on permanent domestic protection from global competition
• For Labor Organizations: Engage proactively in industrial policy design to ensure worker representation and stake in publicly subsidized industrial development projects
• For International Development: Recognize that political economy constraints rather than technical knowledge gaps explain most industrial policy failures in developing countries
• For Investors: Evaluate industrial policy programs based on performance requirements and export mandates rather than assuming government subsidies automatically create profitable opportunities
• For Citizens: Demand transparency and accountability for taxpayer-funded industrial subsidies, including clear metrics for success and public benefits from private investments
• For Researchers: Study successful cases like Korea and Taiwan for their political arrangements enabling government discipline over business rather than just their economic policies
• For Government Officials: Build state capacity for monitoring, evaluating, and disciplining subsidized firms before distributing large amounts of public money to private companies