While subsidies to favored industries are back in fashion, picking winners runs the risk of market distortions and subsidy wars.

For almost four decades since the adoption of the Washington Consensus, mainstream economics viewed state-directed industrial policy as an inefficient tool of twentieth-century planning. State-mandated interventions to steer investment to particular domestic industry sectors were frequently accused of inducing trade distortions, rent-seeking behavior, and taxpayer-funded commercial failures.

However, economists are now asking whether modern state interventions to promote certain industrial sectors risk creating structural inefficiencies and trade tensions after the wave of protectionist measures taken by major economies in 2026. In the face of globalized supply chain vulnerabilities, climate goals, and strategic rivalries, governments are intervening on an unprecedented scale and with an eye toward national security. From the U.S. CHIPS and

Science Act to the EU’s Net-Zero Industry Act (NZIA) and capital allocations throughout East

Asia, governments are taking up local content requirements and state subsidies anew. However, with hundreds of billions of public capital in circulation, the central economic question is whether modern interventionism is capable of building capability without creating structural inefficiencies and trade tensions.

New Thinking Behind Industrial Policy Interventions: From Cost Efficiency

to Resilience

While import substitution industrialization (ISI) policies pursued by developing countries in the 1970s had protectionism at their core, the current resurgence of industrial policy is guided by the need to manage systemic risks. The new thinking behind interventionism is encapsulated in the following three areas:

  • National and Economic Security: With concentrated geographic production of microchips and critical minerals, global supply chains are vulnerable to disruptions. State capital is being allocated to ensure there is a certain level of domestic production of strategic inputs to insulate the economy from globalized production.
  • Accelerating the Energy Transition: Market pricing mechanisms fail to capture climate costs. Direct government interventions in the form of subsidies, tax credits, or guaranteed off-take contracts are being used to accelerate the adoption of new technologies and bring down the cost curve.
  • Technological Sovereignty and Strategic Competition: As new technologies define the contours of power, state capital is being directed to ensure that a country’s firms remain competitive against better capitalized rivals.

Capital Allocation: "Picking Winners" and the Risk of Resource Crowding

Out

The most common criticism of industrial policy is that it is susceptible to resource misallocation. Industrial policy is considered vulnerable to market failures due to the superior information and organizational advantage of government agencies making capital allocation decisions. Critics point to resource crowding-out effects that large-scale state interventions can create for private capital. When state funds are allocated to specific firms or particular technologies (“picking winners”), there is a risk that the following market failures will occur:

  • Resource Crowding Out: Large-scale state interventions increase the cost of scarce inputs (engineering talent, construction, and real estate), which can make it impossible for small private capital to participate in the technology race and adopt new breakthroughs.
  • Political Adhesion and Rent-Seeking Behavior: When private capital receives significant state support, its organizational capacity is redirected toward maintaining the stream of subsidies and shielding itself from competition. Economically viable private capital may therefore become captured by political institutions and slow down the race for innovation and instead seek protection from it.
  • Overcapacity and Glut Cycles: If state interventions are applied across economies to similar industrial sectors (e.g., electric vehicle battery manufacturers), global production capacity far exceeds natural market demand. This creates a situation in which firms must resort to dumping prices and engage in brutal competition for customers, which provokes down-cycles. Supporters of the “new economics of industrial policy” suggest that capability building should be pursued through a mission-oriented approach. Rather than allocating public capital to specific firms and “picking winners,” governments should fund core “horizontal enablers” that facilitate innovation ecosystems and allow commercially viable capital to emerge and thrive. Such enablers can include workforce development academies, shared testing laboratories, and regulatory sandboxes.

Domestic Policies and Subsidy Wars

The wave of domestic content requirements and local sourcing is already triggering WTO-friendly tariff escalation and a complex subsidy competition between major economic blocs. The natural reaction of partner countries to large-scale domestic interventions in another country is to either copy its model or redirect capital elsewhere.

This dynamic has led to a global subsidy competition between countries with significant economic exposure to technology markets. One region’s large-scale green manufacturing tax credits provoke another region to enact its own funding programs (e.g., the EU Net-Zero Strategic Projects). As a result, the WTO principles and rules on prohibited subsidies and trade barriers are circumvented, as countries negotiate bilateral carbon border adjustments, technology security, and trade exemptions.

Guardrails Against Subsidy Waste: Policymaker Considerations

To avoid turning public subsidies into a boondoggle, policymakers must consider the following key factors when designing industrial policy interventions:

Policy Guardrail Operational Mechanism Objective

Clawback Binding statutory requirements This will avoid corporate Provisions & that subsidies be returned in the rent-seeking and provide Performance event of failure to comply with taxpayers with value for Metrics specific R&D, domestic their investment.

capital-deployment, or production targets.

Anti-Entrenchment Explicit expiration dates built into Makes sure that state Sunset Clauses the laws, requiring legislative support is a temporary

reauthorization based on measure, not a independent analysis of a firm's permanent entitlement. performance.

Technology-Neutra Designing tax credits around Preserves competitive l Incentives outcomes (such as dollars markets so that

generated per ton of carbon private-sector innovation reduced or MWh stored). will determine the most cost-effective approaches.

balancing act: a build out of domestic carbon accounting systems, demands on climate finance and technology transfers, and rapid carbon transitions in their high-value sectors to maintain access to lucrative markets.

Works Cited

  • "The New Economics of Industrial Policy," ResearchGate (September 2026).
  • "Picking Winners: Industrial Policy and Monopoly," Journal of Economic Literature (July 2026).
  • "The EU Net-Zero Industry Act Boosts Clean-Tech Manufacturing," Net-Zero Compare (June 2026).
  • "Industrial Policy and the Growth Strategy Trilemma," IMF Finance & Development (March 2023).