Zombification series: is an industrial policy boom coming?

Industrial policy—the targeted intervention of the state in particular sectors—fell out of vogue in Western economies in the 1980s. However, it has become an area of growing interest in recent years, and the coronavirus pandemic has accelerated this trend. Whether this helps to achieve long-term goals, such as combating climate change, or leads to a new generation of unproductive national champions, will depend on the policy framework adopted in 2020‑21. Developments so far in the EU suggest that state spending will be targeted at promoting technology developments that could boost productivity in the medium term; however, in the short term the temptation to support hard-hit firms regardless of future profitability is likely to predominate.

Governments have expanded their use of industrial policy in three broad categories during the coronavirus pandemic. The first is the subsidisation of sectors forced to close or reduce activities because of the outbreak such as hospitality, tourism and the arts. Second, governments have intervened in areas that are crucial in tackling the pandemic, such as the pharmaceutical sector, and the manufacturing of personal protective equipment (PPE) and medical supplies. Finally, governments have been developing plans to spur investment to restart the economy once the pandemic abates—especially green investment.

Wise industrial policy might solve zombification, bad policy will exacerbate it

In the 1980s industrial policy fell out of favour in Western countries because it became associated with inefficiencies; many governments subsidised unprofitable national champions and made politically motivated decisions, dragging on aggregate productivity. These criticisms of industrial policy remain widely accepted today. Governments are generally less efficient in the allocation of resources, and giving the public sector the power to favour certain sectors may create market distortions.

However, recent research—drawing on experiences such as that of the Asian Tiger economies of the 1980s—suggests that industrial policy, if deployed properly, can increase productivity. Governments can invest at a loss for longer than firms, and foster the development of innovative sectors that may become profitable over time. This has become especially relevant in recent years as climate change has moved up the global agenda; addressing global warming requires both the rapid growth of innovative sectors, many of which are not immediately profitable, and significant state intervention.

Will the emergency state aid decisions taken in 2020 increase zombification?

The pandemic has led OECD countries to reconsider using industrial policy as a tool to support their economies. This has renewed fears of a “zombification” of developed economies, ushering in a period of slow growth as heavily indebted, unprofitable companies remain in operation with the aid of government subsidies.

Many of these fears appear to be unfounded, however, or can be mitigated in the following areas.

• Support for the worst-affected industries. In many cases these businesses and sectors will become viable again after the crisis, mitigating the zombification risks. However, in the longer term the comeback of industrial policy could raise dependence on state aid—especially in sophisticated sectors with high barriers to entry, such as airlines—keeping unprofitable firms in business.

• A ramp-up in state spending in pharmaceuticals and healthcare. This creates the potential for waste: several governments struck procurement agreements in 2020 for PPE and testing equipment that turned out to be faulty, for instance. However, this risk of wasteful spending may be mitigated by policies aimed at limiting waste and spurring greater innovation (the rapid development of vaccines is an example).

• The green recovery agenda. Given the size of sums proposed by the EU (€40bn, or US$49bn, under the Just Transition Fund) and the incoming US administration (a US$2trn climate plan), the balance between pro-investment and less targeted industrial policy will have profound implications for global productivity growth after the crisis.

Industrial policy in practice: Europe in 2020 as a case study

In the EU context, the coronavirus crisis has already driven significant changes to industrial policy.

• State aid has ballooned. The EU’s temporary suspension of its fiscal and state aid rules has allowed governments more flexibility, resulting in much heavier state intervention across the bloc. Germany is the most dramatic example of this trend, accounting for almost 50% of total state aid spending in 2020 in the EU.

• Building resilience in strategic sectors has become a greater priority. The disruptions to critical supply chains in early 2020 came as a shock, and drove firms and governments to investigate reshoring and nearshoring options. EU governments have also increased their oversight of investments from outside the bloc this year, either by reducing the size of the stake that can be purchased before government scrutiny kicks in, or by extending the range of “strategic” sectors.

• New money is available for an investment-led recovery. The EU’s response to the crisis includes an EU recovery fund for 2021-24 worth €750bn, on top of the EU’s budget for 2021-27 of €1.1trn (US$1.2trn). Together, these aim to kick-start the recovery with investments and reforms, but also to prioritise research and innovation, climate change and sustainability, and the digital transition. This is a “mission-oriented” approach to channelling funding, with its goals aligned with those of the European Commission more broadly: to build a green, digital and resilient Europe.

The pandemic has accelerated European trends that predated the crisis

Few of these changes are entirely new—the EU’s foreign direct investment (FDI) rules, for example, have been progressively tightened since 2018. Instead, the pandemic has acted as a catalyst to accelerate existing trends, especially those aimed at maintaining the EU’s competitive position in a world that is increasingly dominated by the US and China. EU investment in lithium-ion battery plants for electric cars, for instance, represents an effort to gain a degree of control in an increasingly important industry that is, at present, dominated by China.

“Mission-oriented” industrial policy aims to avoid zombification…

The actions taken by the EU thus far aim to boost strategic investments in productivity. Government efforts to incentivise the use of digital technologies with high growth potential, such as robotics and artificial intelligence, dovetail neatly with private-sector desires to reduce labour costs when reshoring. The EU’s “mission oriented” approach to the recovery fund purposely eschews both “horizontal” industrial policy, which aims to improve the business environment across the board, and “vertical” industrial policy, the much-derided approach of picking winners, which has often proved wasteful and inefficient.

…but the desire to remain globally competitive could prove distortionary

However, there are signs that renewed industrial policy may degenerate into simple favouring of national (or regional) champions. Bail-outs have been targeted at the companies worst affected by the crisis—such as Lufthansa, the largest German airline—rather than at firms that are aligned with a particular strategy. Discussions of allowing mega-mergers that could compete with Chinese state-owned behemoths—such as that floated between French and German rail equipment manufacturers, Alstom and Siemens, in 2017—are being revived. The EU has only three firms in the top 50 global companies by market capitalisation (a French cosmetics firm, L’Oréal, and luxury goods retailer, LVMH, and also a German software firm, SAP), and the EU may want to use the opportunity presented by the coronavirus crisis to respond to China’s economic rise and position EU companies as global leaders.