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Industrial support policies that discriminate against foreign companies are “self-defeating” and harm free trade, the IMF has warned, as wealthy nations including the US increase subsidies for strategically important sectors.
The number of industrial policies used by advanced economies has surged as they seek to boost innovation and curb emissions, the fund found, accounting for more than half of all trade interventions in the past decade. That is well above the share among emerging economies.
Boosting spending on fundamental research and innovation across sectors can, if properly executed, pay for itself in the longer term by raising economic output, said the IMF.
The US and China are among the countries increasing efforts to bolster their industrial bases in key areas including green technologies and advanced semiconductors, sparking fears of rising trade tensions and wasteful subsidies.
“Geoeconomic fragmentation could be self-reinforcing and hard to reverse,” the IMF warned. “As most of the stock of knowledge is imported even for most countries at the technology frontier, policies discriminating against foreign firms can prove self-defeating and trigger costly retaliation.”
The fund highlighted an “abundance of failed programmes”, such as Washington’s synthetic fuels scheme in the 1980s, that testified to the risks of taxpayer money being squandered. History, it found, is “full of cautionary tales of policy mistakes, high fiscal costs and negative spillovers in other countries”.
In the US, the Chips Act and the Inflation Reduction Act, both signed into law by President Joe Biden in August 2022, will dole out hundreds of billions of dollars in tax credits, grants and loans. The subsidies have provoked the ire of close partners including EU capitals which fear the US has ditched free trade as it rewards companies for locating supply chains in the US.
Brussels has opened multiple investigations into Chinese companies, including a probe into wind turbine manufacturers this week, as it seeks to shelter its industry from cheaper foreign competition.
The IMF found that policies that discriminate against foreign companies end up backfiring, given the risk of triggering retaliatory moves and the widespread reliance of companies on overseas technologies.
Another risk is “political capture”, where policy is swayed by sectoral interests but delivers only minimal economic benefit, the IMF said in a chapter of its fiscal monitor, which will be released next week as the fund and World Bank hold their spring meetings in Washington.
The fund said the key to getting the balance right was delivering support to sectors that have “high knowledge spillovers” to other domestic sectors, raising economy-wide innovation and productivity growth. Public research, R&D tax incentives and research grants were the most cost-effective tools for governments to use, the research found.
Properly targeted support for R&D equivalent to 0.5 percentage points of gross domestic product could raise output by 2 per cent for the average advanced economy, the Washington-based fund said in a chapter of its upcoming fiscal monitor.
The policy also lowers the public debt-to-GDP ratio by about 0.5 percentage points over an eight-year horizon. If designed right, innovation policies can therefore pay for themselves in the long term, the IMF added.
The dash for industrial policies comes as countries seek fresh ways of countering sagging growth.
Separate projections from the IMF released on Wednesday showed that global growth would slow to just over 3 per cent by 2029. Absent policy measures to bolster productivity, growth could drop to 2.8 per cent by the end of the decade, it added. That would be around a percentage point below the pre-pandemic average set from 2000 to 2019.
In its annual report, the World Trade Organization has forecast that the volume of world merchandise trade will increase 2.6 per cent in 2024 and 3.3 per cent in 2025 after high energy prices and inflation led to a 1.2 per cent drop last year.
However, WTO economists warned that the use of subsidies to prioritise domestic production, as well as conflicts such as the Houthi attacks on shipping in the Red Sea and wider geopolitical tensions, could dent the expected growth in the global goods trade.
Ralph Ossa, chief economist, told the Financial Times there were early signs of “fragmentation” as developed countries reduced dependence on China and sought to trade more closely with allies.
Additional reporting by Andrew Bounds in Brussels
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