Industrial policy is not a recent phenomenon. Governments have long used it to enhance competitiveness and establish strategic sectors by directing funds and designing supportive regulatory environments to incentivize investment. It aims to create jobs, increase domestic value-added in supply chains, strengthen supply chain resilience, enhance security, and improve the balance of payments. Industrial policy is often justified as a response to market failures such as coordination failures, information asymmetries, capital market frictions, and knowledge externalities.
Industrial policy has gained momentum in recent years against a backdrop of rising geopolitical tensions, security concerns, supply chain bottlenecks, and climate change. However, the current wave differs from earlier ones in two key respects. First, while industrial policy was previously concentrated in developing and emerging economies, it is now led by developed economies (mainly the US and the EU) and China. Second, it has become closely linked to the development of low-carbon sectors and clean technologies for climate mitigation, giving rise to the concept of “green industrial policy.”
Although this new wave has distinctive features, the range of policy tools has not fundamentally changed. Green industrial policies include subsidies, grants, support for R&D, trade barriers, low-interest loans, tax credits, and deductions, local content requirements, standards, regulations, public participation in projects, and public procurement. Interestingly, carbon pricing through carbon taxes or emissions trading schemes does not feature prominently in these policies in most parts of the world. At a time when affordability and competitiveness strongly influence energy and economic policy, it is politically difficult for governments to raise carbon prices enough to change consumer and industry behavior. The development of a global or highly interconnected carbon market also remains a remote prospect, while carbon prices have often been too volatile to provide stable investment signals.
While green industrial policies are essential to advance the energy transition and investment in low-carbon technologies, they can also create distortions that affect both costs and the pace of the transition. Government support may lead to inefficiencies, misallocation of resources, regulatory complexity, and policy uncertainty, including the risk of policy reversals and declining profitability as subsidies expire.
Industrial policies can also create lock-in effects for technologies and interest groups that capture rents, making it difficult to phase out support even when it becomes inefficient. The costs of choosing winners can be particularly high during periods of rapid technological change.
Also, as more countries implement green industrial policies, they are increasingly associated with protectionism and higher trade barriers, including tariffs and export controls, which can undermine the trading system and cross-border investment in globalized supply chains. These measures can slow globalization, raise the cost of deploying clean technologies, weaken technological cooperation, and limit the diffusion of innovation and knowledge spillovers, reducing productivity.
Although the full impacts of these distortions and growing fragmentation remain uncertain, available evidence suggests that the costs are significant. Thus, green industrial policies must be carefully designed, with trade-offs adequately assessed and managed. In the context of rising protectionism and geopolitical fragmentation, these trade-offs are likely to intensify.
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