Industrial Policy

Industrial policy works differently in an open economy. Production crosses borders, firms price above marginal cost, and carbon emissions spill across jurisdictions. International price effects and foreign policy responses therefore shape the domestic payoff from intervention.

The open-economy constraint

A subsidy to a scale-intensive sector can raise output and lower average cost. In a closed economy, domestic consumers and producers receive the resulting gains. In an open economy, higher domestic supply can depress world prices, pass part of the gain to foreign consumers, and induce retaliation. Lashkaripour and Lugovskyy (AER 2023) show that trade policy alone does little to correct the misallocation created by markups and scale economies. Industrial subsidies do not necessarily solve the problem. If the terms-of-trade loss exceeds the domestic efficiency gain, national welfare can fall even as output expands. The authors refer to this outcome as immiserizing growth in the industrial-policy context.

Historical episodes and the coordination question

Korea's Heavy and Chemical Industry drive of the 1970s and China's manufacturing ascent are often cited as successful industrial policies. Lashkaripour and Wu (Oxford RE 2025) review these cases and ask what they imply for similar efforts today. They caution that the global economy is more integrated, retaliation is faster, and fewer sectors remain plausible targets for scale-driven policy. They argue that deep agreements can discipline subsidies and distribute the efficiency gains from joint action. Unilateral efforts are therefore less likely to reproduce the earlier outcomes.

Labor market distortions and technology adoption

Industrial policy can also target the wrong distortion. Farrokhi, Lashkaripour, and Pellegrina (JIE 2024) study how barriers to occupational mobility, informality, and spatial frictions affect firms' technology choices. In low-income countries, these labor-market distortions erode roughly one-third of the productivity gains from trade liberalization. A subsidy to an advanced sector may accomplish little if workers cannot move to the firms that would use the subsidized technology. Addressing the labor-market distortions can matter more than intervening at the sector level.

Why coordination matters

Coordination changes the economics of these interventions. Deep trade agreements that combine tariff reductions, subsidy disciplines, and carbon-border adjustments can deliver welfare gains unavailable to countries acting alone. In economies with markups and scale effects, unilateral policy can redistribute surplus without removing the underlying distortions. Joint action can instead reduce the global wedge between price and marginal cost.