Ahmad LashkaripourDirect answer
Industrial Policy under Scale Economies
Scale economies provide a standard rationale for industrial policy, but international price effects can limit or reverse the gains from unilateral action.
Parent topic: Industrial Policy
With increasing returns, additional output can lower average cost throughout a sector. A firm deciding whether to invest in capacity does not capture this sector-wide cost reduction, so its private return to expansion lies below the social return. This wedge supplies the standard case for industrial policy.
International price effects can reverse this welfare argument. When a country subsidizes a scale-intensive industry, domestic output and world supply both rise. The resulting decline in world prices transfers part of the production gain to foreign buyers. Lashkaripour and Lugovskyy (AER 2023) show that the terms-of-trade loss can exceed the efficiency gain from moving down the cost curve. National welfare then falls even as output rises, an outcome they describe as immiserizing growth.
Markups add a second wedge. Firms with market power restrict output below its socially efficient level. A subsidy that expands output in one country may shift profits across borders without correcting the underlying distortion. Tariffs and export subsidies alone are weak instruments for correcting misallocation when scale economies and markups coexist.
The quantitative models yield a stronger case for coordinated policy. Lashkaripour and Wu (Oxford RE 2025) argue that deep trade agreements that jointly discipline subsidies and reduce tariffs can deliver efficiency gains that unilateral policy cannot reliably secure. By internalizing the terms-of-trade externality, common rules allow countries to expand scale-intensive production without leaving one country to absorb a disproportionate price decline.
The historical cases of Korea's HCI drive and China's manufacturing push operated in a less integrated global economy, where terms-of-trade feedback was weaker. Tighter trade linkages and faster retaliation make those outcomes harder to reproduce today.
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Key questions
Do scale economies automatically justify industrial policy?
No. A firm operating below efficient scale leaves unit costs above their efficient level, so a well-placed subsidy can raise output and lower costs. In an open economy, however, the subsidy also changes world prices. If the subsidized sector exports, the terms-of-trade deterioration can offset or exceed the production gain. The net effect depends on trade shares, demand elasticities, and the response of foreign competitors.