Industrial policy is back—but Europe must now lead

EU ‘strategic autonomy’ requires a revitalised industrial policy which goes beyond the national container.

‘Industrial policy’ has made a comeback in recent times. Before the pandemic, the very term met disapproval and was avoided in public discourse—not only in Germany but also in Brussels. Today, amid the much-vaunted ‘turn of the millennium’ after Russia’s invasion of Ukraine, industrial policy is not only being openly debated but actively implemented. This is evident in the significant public subsidies allocated for chip production, running into billions of euro, or those recently discussed to ease manufacturers’ energy bills.

This change in perception is justified. Well-designed industrial policy has the potential to expedite technological innovation, facilitating the transition to a post-fossil-fuel era. It is also crucial for achieving European ‘strategic autonomy’ and safeguarding our standards of living and way of life.

The past three years have exposed Europe’s vulnerability. The Covid-19 crisis highlighted the lack of essential personal protective equipment, which was no longer being produced within Europe but instead imported from China—a country facing its own shortages. In its wake, disruption in supply chains resulted in a shortage of semiconductors, notably in the automotive industry, hindering economic recovery.

Moreover, Russia’s invasion of Ukraine demonstrated the risks associated with dependence on key imports, such as natural gas, which can be exploited as an economic weapon. These developments have highlighted how excessive dependencies can impede Europe’s ability to pursue its own foreign-policy objectives and undermine its sovereignty.

Daunting task

Without proactive industrial policies, it is challenging to maintain the capacity to produce essential inputs for the European economy. Bringing back production facilities into the EU, especially in critical sectors such as antibiotics, is an even more daunting task.

Securing future incomes and maintaining our standard of living is another important argument for industrial policy. While simplistic models of international trade suggest maximising welfare entails producing goods where costs are lowest, modern economics contributions suggest otherwise.

Scholars such as Ralph Gomory and William Baumol argue that the location of production plays a crucial role in the welfare of nations. In their model of monopolistic competition, economies of scale and sectoral spillovers, globalisation leads to key industries being concentrated in a few countries. These benefit from higher incomes, increased research-and-development spending, technological progress and higher tax revenues. Consequently, it is logical for a country to employ industrial policy to attract leading-edge companies.

Principles violated

The United States and China, the other major global economic blocs, have taken this argument to heart and have upgraded their industrial policies accordingly. Both explicitly aim to locate strategically important industries of the future within their borders and promote them whenever possible.

In pursuit of this goal, the US is even willing to violate basic principles of the World Trade Organization: the Inflation Reduction Act (IRA) grants full subsidies for electric cars or hydrogen production only to those companies which generate a significant proportion of the value added in north America. The WTO prohibits such ‘local content’ rules.

If European countries refrain from active industrial policies while other major blocs engage in them, there is a growing risk that key industries will become concentrated solely in China and the US. This would result in fewer good jobs and lower incomes in Europe and increased dependence on these two powers.

Industrial policy can also be a powerful tool to transpose new technologies from prototypes to large-scale market applications. For instance, Germany’s subsidy programme for renewable energy with feed-in tariffs in the 1990s propelled photovoltaic panels and wind turbines along the learning curve. This made decentralised renewable-energy production profitable and created a thriving market—even if the European Union’s subsequent mismanagement of China’s aggressive move into the fabrication of solar panels has led to an exodus of production facilities from Europe.

National focus

Not all activities labelled as ‘industrial policy’ are however effective, right or fit for purpose. Currently industrial policy in Europe is very largely focused on national interests. EU member states have been granted since the onset of the pandemic greater flexibility to promote individual industries, primarily via significantly relaxed state-aid rules.

What is lacking is a comprehensive European approach, despite some initial elements in the European Green Deal. While the European Commission has commendable ideas and goals, the absence of adequate funding hinders their promotion and implementation.

The problem with national industrial policies is threefold. First, there is a risk they will not only compete with locations in the US or China but also with EU neighbours. This could lead to an intra-European subsidy race, wasting substantial resources.

Secondly, reliance on national industrial policies creates a two-tier Europe: countries with high debt in conflict with European fiscal rules cannot adequately support their industries, while countries with stronger financial positions, such as Germany, can provide substantial support. This threatens not only a new divergence of incomes and economic activity between member states but also discontent in those countries left behind.

Thirdly, a purely national approach jeopardises the single market and competition. Effective competition is essential to prevent companies pocketing industrial subsidies without making efforts to innovate or reduce costs. Experience from other countries demonstrates that industrial policy can succeed when companies face high competitive pressure. By contrast, a national approach risks promoting single national ‘champions’, which may not be agile or economically viable, as opposed to fostering European competition.

European-level approach

Diminishing the role of the European level is particularly detrimental because many transformative solutions could be better addressed there than nationally. For example, producing green electricity, hydrogen and energy-intensive products in the Iberian peninsula or the Balkans where the climatic conditions are most favourable, coupled with a comprehensive transmission network across the EU, could enhance and secure the competitiveness of industries across Europe while generating employment and income in southern Europe. German companies involved in building facilities for production of wind turbines or hydrogen would also benefit.

Successful industrial policy requires an EU-level approach. If individual countries, such as Germany or France, forge ahead independently, it increases the risk of misallocating public funds and alienating other member states, hindering joint solutions which benefit all. Others might then raise barriers against German or French companies, ultimately harming their respective industries and the single market. Despite China and the US being significant growth markets, the EU remains an important domestic market for German and French companies, providing them with the strength to expand globally.

This article concludes the series ‘Beyond the cost-of-living crisis: addressing Europe’s lack of strategic autonomy’, supported by the macroeconomic institute, IMK, of the Hans Böckler Stiftung