Industrial Policies and International Rules: What industrial policies are permissible and to what extent?

AMBASHI Masahito
Consulting Fellow, RIETI

Active use of industrial policies by national governments

In my previous discussion paper on industrial policies (Ambashi, 2021), I argued that the roles of industrial policies in both academia and practice have been reconsidered in recent years. Many researchers have since attempted to clarify the actual state of industrial policies implemented in countries around the world. Their research (Juhasz et al., 2023; Evenett et al., 2024) found that subsidies and export promotion policies have been frequently used instead of import tariffs, that developed countries have been more active in using industrial policies than developing countries, that national security and the resilience of global value chains have become increasingly important as motivations for implementing industrial policies, and that sectors such as low-carbon technologies, advanced technologies, and semiconductors have been subjected to industrial policies.

China's industrial policies and responses to them

One of the factors that has led to the diversification of backgrounds, objectives, and implementation of industrial policies in countries around the world may be China’s active development of its own industrial policies through the “Made in China 2025” initiative announced in 2015. Although it is not easy to elaborate on the full picture of China's industrial policies, they are generally believed to be demand-expanding industrial policies based on China’s vast domestic market, with Marshallian externalities having significant effects in various industrial sectors (Kajitani, 2024) (Note 1). “Marshallian externalities” refers to the positive effects of industrial agglomeration, including an increase in the variety of intermediate goods and the benefits of division of labor due to an increase in final demand beyond domestic needs. This situation leads to increasing returns based on economies of scale (productivity increases with greater production volumes, reducing per-unit production costs). For instance, the Chinese government’s subsidies for electric vehicle (EV) purchases have been interpreted as having supported the above mechanism, leading to the high cost-competitiveness of China’s EV production.

In response to Chinese EVs, which have become internationally competitive, the United States and the European Union (EU) are set to take measures that are arguably problematic under the international rules of the World Trade Organization (WTO). Specifically, the United States is making arrangements to raise a tariff on Chinese EVs to 100% within 2024 under Section 301 of the Trade Act under the justification that China’s EV overproduction under government subsidies poses a threat to U.S. companies and workers. The EU has announced a proposal to impose tariffs of up to 37.6% on top of the current 10% on Chinese EVs for the reason that the Chinese government’s unfair subsidies could damage European companies. In response, China filed a complaint with the WTO claiming that the U.S. Inflation Reduction Act, which promotes EVs and other U.S. products, is impeding fair competition, requesting the establishment of a dispute-settlement panel on the matter. In addition, China has filed a complaint with the WTO against the abovementioned additional EU tariffs on Chinese EVs.

However, the swift U.S. and EU responses to Chinese EV subsidies appear to stem from the awareness that available WTO trade remedies (such as antidumping measures and countervailing duties on subsidies) are insufficient to restore their international industrial competitiveness. In other words, by the time data evidence of the negative impact of Chinese EV subsidies on U.S. and EU EV markets emerges, which would justify WTO trade remedies, China would have already achieved its cost advantages in these markets, making it too late for such remedies to prevent adverse economic effects regarding international competitiveness. As the WTO's right to recourse (the right to seek monetary reimbursement for incurred costs) is prospective rather than retrospective for past damages, there is a problem that even when a plaintiff’s claim against foreign subsidies is recognized, only countermeasures for future damages while subsidies remain are permitted (Bown, 2024).

Even after taking into account such problems with international rules, some argue that raising tariffs in response to China's EV subsidies is a counterproductive strategy (Wagner and Wei, 2024). According to their argument, raising tariffs in a country will only force domestic consumers to buy more expensive EVs without encouraging innovation among domestic EV producers. On the contrary, providing subsidies to domestic producers would encourage them to accelerate innovation, acquire international competitiveness, and provide domestic consumers with cheaper, higher-performance EVs, which would be more desirable from a social welfare perspective. However, it cannot be concluded that such subsidy-competitive industrial policies are permissible under international rules.

International industrial policy rules must be considered

This column discusses industrial policies and international rules, focusing on subsidies. After the conclusion of the General Agreement on Tariffs and Trade (GATT), subsidy disciplines were enhanced through the WTO Agreement on Subsidies and Countervailing Measures (SCM). In addition, the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) has entered into force in 11 countries, including Japan, deepening international rules, including strengthening subsidy disciplines for state-owned enterprises. On the other hand, the roles of industrial policies have been emphasized again in recent years, mainly from the perspective of more actively correcting market failures. Indeed, it has been noted that industrial adjustments which leverage Marshallian externalities and increasing returns to scale have the potential to be effective for the economic development of a country. Especially in developing countries, there is a constant awareness of the advantage of utilizing “policy space” within international rules (Note 2). However, how a single country’s industrial policies affect its domestic economy, its neighboring economies, and the global economy and how the positive and negative effects of these policies should be shared among affected countries have not been adequately clarified to date. Therefore, in order to maintain the stable and predictable global economy and trade system in the future, it remains important to analyze the roles of international rules related to subsidies and other industrial policies and to constantly review these rules. With this in mind, it is important to promote the accumulation of academic knowledge on what industrial policy is permissible and to continue practical examination by policy stakeholders.

September 3, 2024
>> Original text in Japanese

Footnote(s)
  1. ^ Kajitani (2024) calls this Chinese manufacturing industry growth “Smith-Marshallian growth.”
  2. ^ In this sense, there is a view that public procurement can also be an effective industrial policy tool. Garcia-Santana (2024) argues that public procurement policies targeting small and medium enterprises can help them grow and overcome financial constraints.
Reference(s)
  • Ambashi, M. (2021), “Industrial Policy Reconsidered Based on Recent Debates,” RIETI Policy Discussion Paper Series, 22-P-016.
  • Kajitani, K. (2024), “Demand-Expanding Industrial Policies and Their Historical Background: The Case of China,” Journal of economics & business administration, Vol. 228, No. 2, pp. 47-62.
  • Bown, C. (2024), “Modern Industrial Policy and the World Trade Organization”, Annual Review of Economics, 16, pp.243-270.
  • Evenett, S., A. Jakubik, F. Martin, and M. Ruta (2024), “The Return of Industrial Policy in Data”, IMF Working Papers, WP/24/1, International Monetary Fund.
    https://www.imf.org/en/Publications/WP/Issues/2023/12/23/The-Return-of-Industrial-Policy-in-Data-542828
  • Garcia-Santana, M. (2024), “Macro-Industrial Policy: Is the Public Procurement System an Effective Policy Tool?”, Published on Let's Talk Development, World Bank Blogs, World Bank.
    https://blogs.worldbank.org/en/developmenttalk/macro-industrial-policy-public-procurement-system-effective-policy-tool
  • Juhász, R., N. Lane, E. Oehlsen, and V.C. Perez (2023), “The Who, What, When, and How of Industrial Policy: A Text-Based Approach”, SocArXiv uyxh9, Center for Open Science.
    https://osf.io/preprints/socarxiv/uyxh9
  • Wagner, G. and S.J. Wei (2024), “The Right Response to China's Electric-Vehicle Subsidies”, Project Syndicate, 5 April 2024.

September 20, 2024