What exactly is industrial policy? One reason why some scholars have viewed industrial policy negatively is that it is less clearly defined than fiscal and monetary policy.
Here, let us define industrial policy as “government policies aimed at influencing resource allocation by targeting specific industries, companies and technologies.” Why should the government intervene in resource allocation? According to standard microeconomic theory, if markets are perfectly competitive, resources will be allocated efficiently.
In the real world, however, the assumptions underlying this model are not always satisfied. In other words, a “market failure” can occur. In such cases, the government may be able to improve economic welfare by intervening in resource allocation.
For example, public goods, which can be used by many people at the same time and from which free riders cannot easily be excluded, tend to be undersupplied by the market, providing a rationale for government provision. National defense is a prime example of this.
Externalities, which arise when economic activities affect third parties in ways not reflected in market prices, may also cause market failures. As technologies and knowledge generated through research and development (R&D) investment tend to spill over beyond the firms undertaking that investment, the level of private-sector R&D investment tends to fall short of the socially optimal level. In such cases, the government can raise the level of private-sector R&D investment through subsidies or tax incentives.
Another source of market failure is “coordination failure,” which occurs when individuals and firms depend on complementary investments by one another, but a lack of coordination prevents socially desirable investments from materializing. In such cases, the government may attempt to reduce coordination costs by aligning the timing of investments among relevant parties.
These market failures can provide a rationale for industrial policy.
However, industrial policy has also attracted criticism. The government does not necessarily have better access to relevant information than the private sector. If government support is misdirected, it can reduce the efficiency of resource allocation. Moreover, efforts to pick “winners” may end up supporting future “losers.” Such “government failures” could exacerbate, rather than correct, inefficiencies in resource allocation.
>> Original text in Japanese
* Translated by RIETI.
August 3, 2026 - Published in Nihon Keizai Shimbun's " Introduction to Economics—New Trend in Industrial Policy "
