Industrial policy design: what works and what not?

Good policy should focus on niche with complementing ecosystem to attract foreign tech transfer

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ISLAMABAD:

Since 2020, we have seen many industrial policy blueprints unveiled by the G20 nations, including the United States' CHIPS and Science Act, China's Made in China (MIC) 2025 initiative and the European Union's Green Deal Industrial Plan.

From an impressive $53 billion in incentives under the CHIPS and Science Act offered by the US to firms building chip factories to a whopping $1.4 trillion invested in the MIC 2025 initiative, the landscape of global industrial production is changing.

In South Asia, New Delhi has experimented with a myriad of industrial policies; one of which is a DCR (Domestic Content Requirements) scheme that requires component parts for certain projects to be manufactured locally. This gives a huge advantage to domestic manufacturers in public procurements.

Under the DCR, if an Indian government department floats a tender to purchase consumer electronic devices, say 500 laptops, there is a built-in preferential treatment for domestic suppliers.

If the lowest bid comes from a foreign supplier, only 50% of the work order is issued to that supplier and the remaining 50% is awarded to the lowest bidder among domestic players. It is a creative and unique instrument for transferring subsidies to domestic manufacturers through public procurements.

Besides India, we note that many European and western countries like Canada, the US as well as China have some variant of local content incentive policy in public procurements. The DCR is, in fact, one of the top 10 industrial policies used by high-income countries besides other policies such as state loan, trade finance and financial grants.

Similarly, India designed production-linked incentives (PLIs) to transfer huge subsidies to domestic industries during the Covid era. In the past five years, the subsidies enjoyed by large-scale electronics manufacturing sector alone have topped 39,000 crore rupees, with total outlay under PLI exceeding $22.6 billion since 2020.

However, these industrial policies that help to boost domestic production don't guarantee their translation into increased exports and India's exports as a share of GDP have fallen. This is due to over-protectionist policies such as high import duties and localisation requirements.

With no access to cheaper intermediate inputs due to policy barriers, we note that manufacturers can't scale up and hence compete with expensive exports.

India is the only nation in the Southeast Asian region of industrialised nations that has tariffs in double digits – a policy that has deterred the boost to exports. However, India's pro-business approach has helped in some import substitution and has reduced the import bill, but its industrial policies have not been able to increase competitiveness.

In contrast, the US used targeted subsidies under Biden's CHIPS and Science Act to incentivise foreign companies to build fabs in Arizona, along with a threat of tariffs if foreign suppliers fail to do so. Primarily focused on Taiwan which produces 90% of world's chips, this double-pronged approach has somehow worked for the US.

Taiwan Semiconductor Manufacturing Company (TSMC) has invested $65 billion in manufacturing operations in Phoenix and has this month announced investment of a further $100 billion in expansion plans that will double its plants from three to six.

This is the largest single foreign direct investment that the US has ever received and the investment is at least 13 times of what the US gave to TSMC in grants and low-cost loans. Not only that the US enjoys great investment leverage in this case, but these foreign technology transfer projects will also make Washington self-reliant in production of all sorts of semiconductor chips.

From high-end strategic chips used in advanced weapon systems to low-end chips used in cars, President Trump claims that Arizona could account for 40% of the global chipmaking market.

This success story can't be merely attributed to a good policy design as the attractive ecosystem in place also plays a main role. TSMC's fabs produce 4nm chips that are used by Nvidia's high-end GPUs and its future fabs shall be producing even 2nm chips by the end of this decade.

Similarly, Intel Corporation that is under financial stress may be acquired by TSMC's American division in future.

The only missing piece in this new ecosystem and supply chain of strategic chips is the production of rare earths – something that the US could have pocketed, had the Ukrainian rare earth deal not fallen apart at the last moment.

In a nutshell, we see that a good industrial policy should focus on a niche and requires a multi-pronged approach, with an attractive complementing ecosystem to attract foreign technology transfer deals; something that Biden and Trump administrations achieved very skilfully amid recession.

The writer is a Cambridge graduate and is working as a strategy consultant