Raghuram Rajan warns of the pitfalls of industrial strategy

Former RBI Governor Raghuram G. Rajan has critiqued the resurgence of industrial policy under the guise of "industrial strategy".

 
In a special column for Informist, the noted economist warned that the approach may be a repeat of past failures. “Despite numerous examples of misguided industrial policies – often referred to as "white elephants", governments worldwide are again turning to subsidies, protectionism, and regulations to foster domestic firms and job creation”, cautioned Rajan while saying that while industrial strategy may be rebranded with noble intentions, its fundamental flaws remain.

 Drawing parallels to the success of the 1960s U.S. moon mission, proponents of industrial strategy often view it as a means to address pressing challenges, such as climate change.

According to Rajan, this approach appears sensible in theory. Governments break down large objectives, such as reducing emissions, into smaller missions with measurable goals, involving various sectors and stakeholders. However, Rajan argues that these efforts often result in bloated bureaucracies and overly ambitious coordination between ministries, private industries, unions, and civil society.

 The economist points out that the real danger lies in extending industrial strategy beyond governance into the private sector. By using subsidies, loans, tariffs, and tax breaks, governments interfere in markets, distorting competition and market signals.

Rajan believes that this will ultimately stifle private enterprise, as firms are forced to meet government-mandated social and environmental goals rather than focusing on profitability and innovation. As seen in past efforts, this approach leads to cronyism, corruption, and the misallocation of resources.

 
One of Rajan's most pointed critiques is aimed at the current global push for domestic chip manufacturing. Countries are racing to build their own fabrication plants in response to perceived risks, such as global shortages and military needs.

However, Rajan notes that these benefits are exaggerated. No country can produce all the chips it needs, and global issues, like pandemics, will still disrupt domestic supply chains. Moreover, government intervention in chip production could worsen the situation, leading to higher costs and reduced efficiency.

The national-security argument for domestic manufacturing, Rajan argues, also fails to hold up. He points to Russia's ability to conduct a large-scale war, despite sanctions from chip-producing countries, to illustrate the limitations of a domestic-focused strategy.

Ultimately, Rajan warns that the costs of industrial strategy are too high. Governments pour subsidies into industries, often for uncompetitive firms, furthering dependency on state support. This hinders innovation and reduces industry-wide profits. Rajan advises that mid-sized economies, like India, would be better off investing in education and infrastructure instead of chasing industrial dreams with unsustainable subsidies.

With the rise of industrial strategies focused on electric vehicles, solar cells, and batteries, Rajan cautions that governments risk hindering global efforts to combat climate change. Instead of fostering innovation and collaboration, these policies may create inefficiency and fragmentation, leaving the world worse off in the long run. Rajan concludes with a call for global dialogue to find the proper balance between industrial strategy and market-driven solutions.