Industrial policy often walks a tightrope between overreach and neglect. Excessive government intervention can lead to market distortions, dampen competitive dynamics, and foster inefficiencies, turning the economy into a bureaucratic drag. Yet, a laissez-faire approach can leave market failures like negative externalities and public goods under-provided, destabilising the economy. The key is to apply just the right amount of regulatory nudge — enough to correct market failures and guide resource allocation efficiently, but not so much that you kill the goose that’s supposed to lay the golden eggs.

India’s industrial policy post-Independence, much like the absurdity in Alice in Wonderland and the oppressive control in Orwell’s 1984, created a system where progress was trapped in a maze of bureaucracy. The Industries (Development and Regulation) Act of 1951 birthed the “license-permit raj,” where every industrial decision required government approval, turning ambition into a bureaucratic hurdle. The Monopolies and Restrictive Trade Practices (MRTP) Act of 1969 and the Foreign Exchange Regulation Act (FERA) of 1973 further restricted growth and isolated Indian industries from global competition. Intended to protect and foster growth, these policies instead stifled innovation and redirected business efforts towards navigating regulatory obstacles rather than competing in the market. This legacy of excessive control and inefficiency is precisely why industrial policy has earned a bad name in India. It is often vilified as a harbinger of inefficiency and protectionism.

However, the recent resurgence of industrial policy, after a period of decline, is driven by a global rethinking of market-driven approaches and the challenges posed by technological disruption, economic stagnation, and geopolitical competition, particularly with China. Developing countries, disillusioned with the Washington Consensus, seek proactive government interventions to diversify and upgrade their economies, while advanced economies grapple with declining manufacturing employment and the lingering effects of the financial crisis. China’s rapid industrialisation, coupled with rising concerns about technological transfer and competition, has prompted both protectionist measures and calls for stronger industrial strategies in the US and Europe. Technological changes, including automation and digitalisation, further emphasise the need for government involvement in shaping economic activities.

But what is industrial policy? Juhász, Lane and Dani Rodrik (2023) conceptualise industrial policies as government interventions specifically designed to alter the composition of economic activities in pursuit of predetermined public objectives. These objectives typically encompass enhancing innovation, increasing productivity, and fostering economic growth. However, they may also extend to objectives such as facilitating the climate transition, improving labour market outcomes, reducing regional disparities and expanding export capacity. A defining feature of industrial policy is its inherent selectivity, wherein policymakers exercise allocative discretion — strategically prioritising certain sectors or industries over others to induce structural transformation, albeit with the implicit trade-off that some sectors may be de-prioritised.

While the Production Linked Incentive (PLI) scheme is often seen as an industrial policy, it primarily offers financial incentives to boost manufacturing in specific sectors and does not fully address the broader structural challenges needed to transform India into a global manufacturing hub.

There are several reasons why India needs an industrial policy. The first reason is grounded in straightforward, undeniable logic. Structuralist economists like W Arthur Lewis and Albert O Hirschman emphasise that economic development involves transitioning from agriculture to manufacturing and services. India’s economic structure remains skewed towards agriculture, which employs a disproportionate workforce despite contributing a declining share of GDP.

Why go for a new policy

A well-designed industrial policy can guide this structural transformation, facilitating the shift towards more productive sectors essential for sustained economic growth. There are three reasons why India should come up with a new industrial policy

First, Romer (1990) and Lucas (1988) provide a basis for understanding how government intervention can foster innovation and knowledge spillovers, leading to sustained economic growth.

Second, Stiglitz and Greenwald (2014) in “Creating a Learning Society” provide a theoretical foundation for industrial policy by demonstrating how learning and innovation are endogenous processes that require government support. Their work is backed by data on productivity growth in sectors where state intervention facilitated technology transfer and skills development, particularly in industries such as electronics and automotive manufacturing in countries like Japan and Germany.

Third, Joseph Stiglitz and George Akerlof have extensively written about the inefficiencies in resource allocation driven by information asymmetries, externalities, and the public goods problem. In India, these market imperfections are particularly evident in sectors such as research and development (R&D) and infrastructure, where private firms underinvest because they cannot fully capture the returns on their investments.

Information asymmetry leads to suboptimal investment in R&D, while the non-excludable nature of infrastructure deters private sector involvement, resulting in gaps in essential services. However, instead of broad government intervention, a market-oriented industrial policy can strategically target these inefficiencies by providing selective incentives and fostering a more favourable business environment.

Fourth, empirical studies in this domain show that countries with active industrial policies tend to experience higher rates of total factor productivity growth, as seen in the case of China’s strategic investments in high-tech industries (Lin, 2012). The phenomenon of premature deindustrialisation, as discussed by Dani Rodrik, occurs when developing countries begin to deindustrialise at much lower income levels than historically industrialised nations. This can lead to a situation where economies fail to fully exploit the productivity gains from manufacturing before transitioning to a service-dominated economy, resulting in lower overall growth and limited job creation.

Fifth, the Developmental State Theory of Amsden (1989) and Johnson (1982), provides historical evidence of the effectiveness of industrial policies in driving rapid industrialisation in East Asia, with data showing significant increases in GDP per capita and manufacturing value-added in these economies during the periods of active state intervention.

Sixth, geoeconomics, a field explored by scholars like Edward Luttwak, emphasises using economic instruments to achieve geopolitical objectives. Economic strength is a critical component of national security in a multipolar world. India’s industrial capabilities, particularly in strategic sectors like defence manufacturing, telecommunications, and critical technologies, are essential for maintaining strategic autonomy and reducing dependency on foreign powers. An industrial policy that prioritises these sectors can align economic growth with national security objectives.

The writer is Officer on Special Duty, Research at Economic Advisory Council to the Prime Minister. Views are personal

India’s economic structure remains skewed towards agriculture, which employs a disproportionate workforce despite contributing a declining share of GDP

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