Research Highlights Podcast
January 23, 2025
The returns to industrial policy
Panle Jia Barwick and Myrto Kalouptsidi discuss how China subsidized its rise to becoming the world’s leading shipbuilder.
Source: notice44
Between 2006 and 2013, China’s government poured enormous resources into its shipbuilding industry through various subsidies—from providing free coastal land to offering financing assistance for ship buyers. But estimating the true scale and impact of these policies is challenging, as governments are often opaque about their industrial support programs.
In a paper in the Journal of Economic Perspectives, authors Panle Jia Barwick, Myrto Kalouptsidi, and Nahim Bin Zahur developed new methods for overcoming these measurement challenges and quantifying China’s support for its shipbuilding industry.
Their research reveals which types of industrial policies work best, when they should be implemented, and why countries might pursue them even when the direct economic returns are low. These insights are particularly relevant today, as countries around the world are increasingly embracing industrial policies to support strategic sectors.
Barwick and Kalouptsidi recently spoke with Tyler Smith about how they measured China's shipbuilding subsidies, why entry subsidies are particularly inefficient, and the importance of timing industrial support with market cycles.
The edited highlights of that conversation are below, and the full interview can be heard using the podcast player.
Tyler Smith: First, I think it is worth elaborating on the term “industrial policy.” Can you explain what that means and what the primary goals of industrial policy are?
Panle Barwick: Industrial policy is a very broad term to many people. Different people might have different meanings, but we think it refers to a government's agenda to shape industry structure by promoting certain industries or certain sectors. I think that probably broadly captures the industrial policies. I think the government's objectives in implementing industrial policies aren't always transparent. In fact, they're always quite opaque. So, in this article, we try to look for clues as to why countries are doing that in shipbuilding specifically. It's closely connected to trade and shipping. So, given that many countries want to promote their trade, shipbuilding is naturally a consideration factor. And producing ships, particularly the largest commodity ships, requires complex production, technology, and is very capital intensive. So it is often perceived by many countries as a crucial component of industrialization. It may also have implications for military and national security. In South Korea, for example, part of motivation for shipbuilding was the withdrawal of the US military. The country realized it needed to build its national defense.
Smith: When you estimate how much China subsidized the shipbuilding industry, you get something like $90 billion between 2006 and 2013. I'm wondering if you can put that in context for me and explain what China got for that investment in their shipbuilding industry.
Barwick: So, $90 billion sounds like a lot, but it's important to recognize that a big portion of that is driven by entry subsidies. Entry subsidies are mostly in the form of free land. Valuable coastal regions were given to those shipyards for a very low price or sometimes even free. The total subsidy was $90 billion. And entry subsidies were roughly $70 billion. And the rest were $20 billion of production subsidies and investment subsidies. Production subsidies were roughly $20 billion in the form of the cheap input and buyer financing—in the form of a collateral loan given to potential buyers because ships cost millions of dollars, sometimes tens of millions of dollars. Having a collateral loan from the government is very attractive for potential buyers. Investment subsidies were around $5 billion, and that is primarily in the form of low-interest, long-term loans, as well as tax policies that allow firms to expedite their capital depreciation.
Smith: So it sounds like there's a number of different ways that China is subsidizing its shipbuilding industry. I think an interesting question is which types did you find seem to be the most efficient?
Myrto Kalouptsidi: Overall, I think we do find large support for the industry. Our main finding is that they get very little in terms of pure economic returns. I think we have a negative return of 80 percent. So you give $1, you get back $0.20. Because the entry subsidies are such a big chunk of it, this negative return is driven by these entry subsidies. In retrospect, this is a very intuitive finding, because what's happening is if you give a subsidy to a firm to enter, this means you're lowering the threshold that a firm needs to overcome in order to enter. So a firm thinks, how much money do I need to make to enter? How much am I going to pay? And there's going to be some firms that are marginal, that are expecting to make just below the cost. And all of a sudden you're lowering the cost, which means that it becomes profitable for these firms to enter. But of course, if these are the firms that have the lowest expected profitability, they are the least productive firms. So all of a sudden when you lower entry costs, you allow the least productive firms to enter. And because an important feature of this industry is its high volatility—demand spikes and demand busts—you have all these unproductive firms who are exacerbating excess capacity. They're bringing prices down. They're making volatility worse. This was a big reason behind this low return that we're finding.
The reason entry subsidy is so wasteful in our setting is it's just a blank policy. Anyone who wants to set up a shipyard can get free land. That's not a very effective policy because it attracts inefficient firms.
Panle Barwick
Smith: What role did timing play on the effectiveness of these subsidies? When is the best time to subsidize an industry?
Kalouptsidi: This is also related to the volatile nature of the industry and the fact that it undergoes these booms and busts, the so-called shipping cycle. We realized that in the case of China, subsidies were largely pro-cyclical, which means that the biggest subsidy boom happened in 2006, which was actually a period of very high demand. This is a period where China is growing really fast. It imports a bunch of raw materials and exports manufactured goods. There was a massive increase in demand. Actually, the spike in shipping rates at the time were higher than those during COVID for certain types of products. At that point, I think the backlog of new ships increased eightfold within a couple of years. And then in 2008, the Great Recession hit, and you had a historical bust of the industry. So the subsidies came on right when demand was peaking. But what happens when you subsidize during a boom is that you're kind of giving incentives for firms to produce more and enter when production costs are higher, because all of these firms are now producing close to capacity, which means they're producing at a high cost. In contrast, if you subsidized during the bust, this is a period of very low utilization and idleness. So you would be utilizing resources that are sitting around. We find that the return is much higher if you subsidize during the bust compared to a boom.
Smith: There are a lot of countries right now who are reinvigorating their interest in industrial policy. If you were talking to a policymaker interested in ramping up industrial policy, what sorts of things would you say they should keep in mind?
Kalouptsidi: It might sound obvious, but I think it's important to keep in mind the goals. One has to think hard about what they want to achieve by adopting a certain policy mix. Do they want growth? Do they want welfare? Do they care about distribution? So you have to be clear about the goals that you're trying to achieve. And of course geopolitics are going to come into this as well—national security resilience. And then the things that we specifically get out of our research is that the timing matters and the heterogeneity matters. One aspect that doesn't come into play in our work, but I think really matters is probably market power. In shipbuilding, this turns out not to matter. But in other industries, this could be important, and you might want to think about these considerations along with industrial policy.
Barwick: Industrial policies will distort market behavior and, as a result, induce rent seeking and promote the participation of more inefficient firms. The reason entry subsidy is so wasteful in our setting is it's just a blank policy. Anyone who wants to set up a shipyard can get free land. That's not a very effective policy because it attracts inefficient firms. So that's why I think investment and production subsidies are more useful. If you're a good firm, then you're more likely to attract buyers and get loans. So understand that firms are different and design policies that attract efficient firms. Also, in China’s setting, I think to their credit, the government was nimble and able to change policies. From 2006, there was massive policy support. But in 2009, it was clear that the industry had over-expanded. So they put in place an entry ban right at the peak in 2009 and 2010 and then shifted the policy quite quickly from subsidizing everybody to focusing on incumbents. Then in 2013, they implemented the so-called “White list” policy that focused on not just incumbents but also high-quality incumbents. So I think the ability to change directions is also an important lesson.
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“Industrial Policy: Lessons from Shipbuilding” appears in the Fall 2024 issue of the Journal of Economic Perspectives. Music in the audio is by Podington Bear.