A new report by the International Monetary Fund (IMF) has raised concerns about the potential drawbacks of industrial policies that heavily rely on costly subsidies or tax breaks. The report, titled “Industrial Policy Is Not a Magic Cure for Slow Growth,” argues that such measures could be detrimental to productivity and welfare if not effectively targeted.
According to the IMF, while industrial policy, which involves governments supporting specific sectors, can drive innovation when implemented correctly, striking the right balance is crucial. The report highlights that history is replete with cautionary tales of policy mistakes, high fiscal costs, and negative spillovers across countries.
The report notes that many countries are ramping up industrial policy to boost innovation in specific sectors, to reignite productivity and long-term growth amidst security concerns. However, the IMF warns that “most industrial policy relies heavily on costly subsidies or tax breaks, which can be detrimental to productivity and welfare if not effectively targeted.”
The report cites examples where subsidies are misdirected toward politically connected sectors or when policies discriminate against foreign firms, which can trigger costly retaliation and hamper innovation from external sources.
While acknowledging that industrial policy can be justified in certain cases, such as supporting sectors with strong knowledge spillovers or driving green innovation, the IMF emphasises the need for transparency, a focus on environmental objectives, and complementary carbon pricing to minimise fiscal costs.
The report advises governments deploying industrial policies to invest in technical capacity, recalibrate support as conditions change, and act in line with open and competitive markets. It also highlights that “well-designed fiscal policies that support innovation and technology diffusion more broadly, with an emphasis on fundamental research that forms the basis of applied innovation, can lead to higher growth across countries and accelerate the transition to a greener and more digital economy.”
The IMF’s warning comes as the recently inaugurated administration of President Bola Tinubu in Nigeria has embarked on widespread reforms, including the discontinuation of fuel subsidies and the floating of the local currency, which have received praise from international observers. The IMF had previously commended Nigeria and three other countries for recent subsidy reforms that would create space for development spending.