Industrial policy in the EU: new opportunities, old risks?

Prepared by Sam Langfield, Daphne Momferatou and Ralph Setzer

1 Definition and relevance for central banks

Industrial policy can be defined as government intervention that targets the structural transformation of economic activity in pursuit of a public goal. Industrial policy deliberately directs factors of production to specific sectors. Conceptually, this distinguishes industrial policy from macroeconomic stabilisation measures and structural policies that aim to improve the general business environment (Juhász et al., 2024). While structural policies can also have uneven effects – for example, a research and development (R&D) tax credit would favour R&D-intensive industries – the conceptual distinction is useful for identifying policies explicitly designed for sectoral reallocation.

While market failures can be the rationale for industrial policy, its selectivity creates efficiency and governance risks. Industrial policy can help address coordination failures, knowledge externalities and vulnerabilities (International Monetary Fund, 2025). However, because interventions selectively promote specific sectors or activities, opportunity costs are implicit. Shifting resources away from potentially more productive uses risks allocative inefficiency owing to the bounded knowledge of policymakers and the potential for rent-seeking behaviour, especially in environments with weak institutional quality. Historically, this has often led governments to support politically influential incumbents rather than address genuine market failures (Grossman and Helpman, 1994). The open question is whether modern industrial policy can overcome informational frictions, resist undue influence from vested interests and avoid institutional inefficiencies in a contemporary European Union (EU) context.

Governments implement industrial policy, the macroeconomic effects of which can affect monetary policy transmission. Sector-specific interventions alter relative prices, for example by subsidising factor costs. Other general equilibrium effects emerge from cross-border spillovers, policy responses by other governments and fiscal implications. Effective interventions can raise potential growth or dampen the inflationary impact of price shocks. Poorly designed measures, however, can subsidise capacity-constrained sectors and distort economic decisions. Nationally differentiated industrial policies can also affect cross-country competitiveness and financial fragmentation, with implications for monetary policy transmission. For these reasons, it is important for central banks to assess the design and macroeconomic effects of industrial policy.

Industrial policy has re-emerged worldwide in response to geoeconomic fragmentation, rapid technological change and the climate transition. The remainder of this article documents the resurgence of industrial policy, reviews the evidence of its effectiveness and examines the specific opportunities and risks it presents in the EU context. It then identifies key principles for the design of industrial policy in Europe.

2 Resurgence of industrial policy

The use of industrial policy has expanded across major economies. Governments deploy targeted grants, equity and credit support, trade measures and localisation requirements to promote selected sectors. There has been an increase in the number of such measures in the EU and its Member States, with similar patterns in the United States and China (Chart 1, panel a). Researchers have likewise shown renewed interest in industrial policy, with the share of publications referencing industrial policy having more than doubled since 2020 (Chart 1, panel b).

Three structural trends – geoeconomic fragmentation, technological progress and climate change – underpin this renewed attention to industrial policy.

First, geoeconomic fragmentation exposes supply chain vulnerabilities and raises concerns about resilience. The pandemic and recent conflicts have highlighted the macroeconomic risks associated with external dependencies. The more interventionist trade policy stance in the United States and technological upgrading in China, partly supported by domestic industrial policy, are further reshaping global production networks. While lower import prices improve the terms of trade, reliance on foreign capacity increases exposure to supply disruptions and geoeconomic coercion, motivating policymakers to intervene as insurance against price and quantity shocks.

Second, rapid technological change generates discrete outward shifts in potential output. Breakthroughs in general-purpose technologies, including artificial intelligence and robotics, raise the opportunity cost of operating behind the global productivity frontier. Technological dynamism can motivate intervention in specific sectors to stimulate domestic innovation (by addressing knowledge spillovers and financing constraints) or accelerate adoption (by targeting coordination failures and network externalities). Effective implementation of innovation-oriented industrial policy means overcoming informational constraints so that market failures can be targeted precisely.

Third, the climate transition requires large-scale investment in physical capital. Carbon pricing is the primary policy used to incentivise necessary capital formation, by correcting the underlying environmental externalities. However, price signals may be weakened by barriers to investment, including coordination failures in infrastructure deployment, network effects in green technologies and financial frictions. This could provide a rationale for climate-motivated industrial policy to complement carbon pricing through sectoral interventions.

Stated reasons for intervention broadly align with these structural trends, but the emphasis differs across economies. EU measures are more often climate-related, US measures place greater weight on resilience, and Chinese measures are more often framed around competitiveness.^[1]

3 Policy instruments and empirical effectiveness

Surveying the range and targets of policy instruments

Modern industrial policy draws on an established policy toolkit. Based on Evenett et al. (2024, 2025), this article focuses on sector-specific instruments that can be classified in terms of whether they provide financial support or restrict market access.^[2] This classification is necessary because outcomes may diverge from stated policy intentions.

Grants: non-repayable grants, tax and social insurance relief, production subsidies, in-kind transfers and price stabilisation measures alter firms’ cost structures. Similar effects can also arise indirectly, for example when public procurement or defence contracts support related civilian technologies or firms. These tools provide immediate support but carry fiscal costs. If deployed without strict conditionality and exit criteria, subsidies are vulnerable to pressures from vested interests, leading to resource misallocation by shielding supported firms from market discipline.

Equity and credit: state-sponsored loans, guarantees, interest payment subsidies and equity capital injections transfer risk from private balance sheets to the public sector. These interventions can support targeted sectors by lowering the cost of capital for recipient firms, especially those developing new technologies (see Box 1). Their effectiveness, however, depends on careful design: poorly designed measures can generate fiscal liabilities, crowd out private investment and sustain unproductive firms.

Trade policy: governments implement import tariffs, quotas, anti-dumping duties and export controls to influence the prices and quantities of foreign goods relative to domestic goods in specific sectors. Such measures can insulate domestic production capacity from external competition and secure supply. However, they can raise downstream costs and interfere with comparative advantage, disrupting global supply chains and increasing retaliation risk. From a fiscal perspective, the net impact of trade measures is ambiguous; while tariffs can generate revenue, outcomes depend on import elasticities.

Localisation: local content requirements, procurement preferences, restrictions on foreign direct investment and sector-specific regulations limit market access. While these interventions can coordinate technological standards and establish domestic capacity without significant fiscal implications, they serve as implicit protectionism. Compliance costs distort firm-level decisions, and barriers to cross-border investment and competition risk fragmenting markets, with the magnitude of these effects depending on the coverage of the measures.

The industrial policy mix varies across major economies. Measured by the number of recorded interventions between 2020 and 2024, the EU and its Member States together rank highest in the G20, with equity and credit support the most frequently used instrument, partly reflecting the deployment of measures related to the pandemic and the energy crisis (Chart 2, panel a). Intervention counts, however, do not capture fiscal scale and are affected by differences in transparency: the EU’s State aid framework makes its measures particularly visible. China records fewer interventions but relies on larger-scale fiscal and quasi-fiscal support, including grants, support for state-owned enterprises and state-directed finance (Garcia-Macia et al., 2025 and Attinasi et al., 2026). The United States exhibits a more uniform policy mix, with a notable use of localisation requirements. Other G20 countries deploy industrial policy on a smaller scale and tend to rely more on trade-related measures.

Macroeconomic effects also depend on the specific sectors targeted for intervention. Natural targets for intervention include sectors responsible for supply chain bottlenecks and emerging R&D-intensive sectors. Jakubik and Langfield (2026) find some evidence of policy targeting bottlenecks, but little evidence of R&D targeting. Instead, industrial policy interventions are more common for products that already account for a large share of exports (Chart 2, panel b). While interventions may intend to defend export sectors against state-subsidised foreign competition, an unintended consequence may be that they shield established incumbents from market discipline.

Empirical assessments of effectiveness

Assessing the effectiveness of industrial policy requires an economy-wide approach. Welfare assessments must consider whether factor displacement effects are justified by gains in productivity or resilience. While any evaluation requires a counterfactual, resilience is harder to observe and quantify, especially if an adverse shock does not materialise. Consequently, the empirical literature focuses mainly on observable outcomes such as investment, employment and productivity. Yet the same economy-wide trade-offs apply to resilience objectives: even if targeted interventions build resilience at sector level, they can reduce it on aggregate, for example by diverting resources from other critical activities or entrenching protected incumbents.

Early empirical evaluations found that sectoral interventions tended to channel resources to declining industries, contributing to depressed productivity growth. Cross-country panel evidence suggested that support was often misdirected (Pack, 2000), a finding echoed by studies of East Asia, including Japan (Beason and Weinstein, 1996) and South Korea (Lee, 1996), and by early European evidence on State aid allocation (Neven and Röller, 2000). Informational constraints and vested interests caused policymakers to support incumbents rather than high-potential sectors facing market failures (Pack and Saggi, 2006). This literature gave rise to a long-standing presumption that industrial policies are unlikely to improve total factor productivity.

More recent literature identifies specific contexts in which industrial policy can resolve sector-specific market failures in emerging economies. By exploiting firm-level data and improved identification strategies, these studies distinguish policy effects from underlying sectoral trends. Successful interventions rely less on open-ended protection than on conditional support and continued competition, allowing unproductive firms to exit (Aghion et al., 2015 and Lane, 2020). However, when institutions are weak, the same tools can sustain inefficient incumbents and generate overcapacity (Barwick et al., 2025 and Fang et al., 2025). Consistent with these concerns, recent evidence links industrial policy in China to lower aggregate productivity through factor misallocation (Garcia-Macia et al., 2025).

In mature economies, policy justification extends beyond coordination failures to include underinvestment in knowledge, as well as resilience and security objectives. Public research and procurement agencies in the United States have been shown to accelerate technological development by targeting early-stage innovation and promoting knowledge spillovers (Gross and Sampat, 2023 and Gazzani et al., 2025). The evidence on production subsidies is more mixed: expanding capacity in targeted sectors diverts resources from non-subsidised competitors while incurring fiscal costs (Goldberg et al., 2024). The literature therefore suggests that the benefits to industrial policy in mature economies are more clearly established for foundational research than downstream production.

Assessments of interventions in Europe demonstrate the difficulty of translating targeted support into aggregate productivity growth. Brandão-Marques and Toprak (2024) find that EU State aid has positive effects on employment and revenues in recipient firms, but no effect on investment or productivity. They also find adverse spillovers to competing non-recipient firms, which can offset the direct benefits of support within the Single Market. Evidence from regional interventions in the United Kingdom is consistent with this pattern, showing that support increased recipient employment without improving total factor productivity (Criscuolo et al., 2019).

Constraints on industrial policy are tighter in open economies. Across integrated markets, uncoordinated national subsidies can alter relative prices and distort comparative advantage (Hodge et al., 2024). Likewise, import tariffs intended to shield domestic capacity raise input costs for downstream manufacturing, dampening sector employment (Flaaen and Pierce, 2026). To address these challenges, industrial policy should preserve a level playing field and limit the influence of vested interests.

4 A new industrial policy strategy for Europe

Features specific to the EU context

In the EU, governments pursue industrial policy across a partially integrated Single Market. Decentralised industrial policy risks distorting competition by allocating resources according to countries’ differing abilities to intervene and preferences as to where to do so, risking subsidy races. Limiting this distortive effect is a key underlying principle for State aid rules: while these rules constrain the provision of selective economic advantages to firms or sectors, Member States still provide substantial fiscal support through industrial policy, the overall scale of which is subject to measurement challenges (see Box 2). More intensive use of fiscally costly industrial policies may require further EU-level coordination and, where appropriate, common decision-making or centralisation of policy instruments. This could help mitigate local capture risks, safeguard competition across the Single Market and reduce the scope for local maladministration.

Fragmentation risk is compounded by uneven institutional quality across Member States. Discretionary intervention demands “embedded autonomy”: the state must be informed on the sources of friction while resisting rent-seeking and withdrawing support according to predefined exit criteria (Rodrik, 2004). Yet institutions vary across Europe. At national level, regulatory quality and control of corruption differ significantly across country groups (Chart 3, panel a). At regional level, weaker quality of government is associated with lower labour productivity (Chart 3, panel b). Regions in need of productivity-enhancing investment may lack the administrative capacity to design and monitor interventions, exacerbating resource misallocation and political capture.

The effect of industrial policy also depends on financial structure and regulatory impediments to cross-border activity. In the EU, support is largely provided through credit and guarantees channelled via national banking sectors, which favour domestic capital-intensive firms with established bank relationships. Such support can therefore reinforce incumbency bias. Fragmented equity markets restrict the supply of risk finance, especially for firms that are reliant on intangible capital. This bank-based financial structure weighs on economic growth (Langfield and Pagano, 2016), while disparate national regulatory and insolvency frameworks constrain cross-border expansion at firm level (Baumann et al., 2026). Sector-specific interventions cannot therefore substitute deeper market integration. Advancing the savings and investments union, including through common frameworks in corporate law and pension reform, would help mobilise risk capital and improve the effectiveness of industrial policy in innovation-intensive sectors (Arampatzi et al., 2025).

Europe’s institutional and financial architecture defines its position relative to the global technological frontier. R&D expenditure relative to GDP is lower in the EU than in the United States, reflecting weaker business sector investment (Chart 4, panel a). The sectoral composition of R&D in the EU is concentrated in established industrial sectors (Fuest et al., 2024), with high-technology sectors receiving lower allocations (Chart 4, panel b). This composition matters for productivity, as high-tech sectors generate stronger spillovers and account for a significant share of the EU-US productivity gap (Bothner et al., 2026 and Coatanlem and Coste, 2025).

Alongside these institutional and financial frictions, the EU’s relatively open economy shapes which industrial policies are most appropriate. The EU economy exhibits greater openness to external trade than the United States or China. Deploying trade-restrictive measures such as tariffs or local content requirements can trigger retaliation and geoeconomic fragmentation (Baba et al., 2023 and Rotunno et al., 2026). These constraints are particularly relevant for climate-related industrial policy, where the EU faces trade-offs between climate ambition, trade openness and preserving the Single Market (Wunsch and Langenus, 2026). Fragmentation can weigh on economic growth and reduce resilience by weakening the diversified trade networks that help economies absorb external shocks. For export-oriented EU manufacturing, these costs may outweigh the shorter-term benefits of shielding domestic industries. Preserving competitive neutrality and multilateral trade frameworks is therefore still important.

Europe’s distinct institutional, financial and macroeconomic features limit the scope for direct replication of foreign industrial policies. The Draghi report calls for EU action to be refocused on policy priorities, supported by stronger coordination, simplified rules and better targeted financing (Draghi, 2024). The EU has introduced several legislative initiatives, including the Net-Zero Industry Act, the Critical Raw Materials Act, the European Chips Act and the Tech Sovereignty Package. Furthermore, the Industrial Accelerator Act proposal aims to introduce targeted public procurement and foreign direct investment rules. The Commission’s proposal for the next Multiannual Financial Framework would reorient spending towards EU-wide priorities, alongside a transition from a programme-based budget to a policy-based framework intended to better target EU funds and a move from cost-based payments to performance-based disbursements. The macroeconomic outcomes of these initiatives will depend on their concrete design and alignment with evidence-based design principles, including effective coordination between EU and national levels.

Industrial policy design principles in the EU context

The EU context calls for policy design principles that integrate international evidence with the specificities of a multi-country Single Market. EU-level industrial policy can help limit the fragmentation and subsidy races associated with uncoordinated national interventions, while pooling resources to achieve scale in targeted activities or sectors. The EU can build on existing frameworks, including State aid control and performance-based instruments such as the Recovery and Resilience Facility, which offer relevant experience in linking funding to results. At the same time, differences in institutional quality and national regulatory frameworks, together with Europe’s bank-based financial system, can amplify risks of resource misallocation. Five design principles are therefore relevant to strengthen governance, safeguard cross-border competition and ensure that industrial policy complements structural reform.

First, industrial policy benefits from clearly defined objectives in order to inform instrument selection and define criteria for ex-post evaluation. Productivity and resilience-related objectives ought to be differentiated, and broad motivations should be translated into operational targets. Interventions aimed at economic resilience require particularly narrow targeting to prevent mandate expansion. A lack of precision risks shielding incumbents rather than resolving specific dependencies and improving economy-wide resilience.

Second, the targeting of specific sectors depends on linking interventions to well-identified market failures. Where the objective is productivity growth, interventions are most efficient when directed at activities with knowledge spillovers, such as frontier technologies in areas where the EU is lagging behind. This avoids using scarce fiscal resources to subsidise incremental innovation by financially unconstrained incumbents. Where the objective is resilience, targeting should be based on empirical identification of critical dependencies and supply chain vulnerabilities. Labelling a sector “strategic” is insufficient; designation must be accompanied by economic analysis and clear identification of the public interest objective, whether related to market failures, resilience, or security concerns.

Third, preservation of the Single Market calls for mechanisms that account for cross-border externalities. National subsidies can distort competition and create negative cross-border spillovers. To avoid subsidy races and capture economies of scale, interventions should prioritise common EU instruments. While operating at EU level mitigates concerns regarding Single Market fragmentation, it does not eliminate the need for safeguards against resource misallocation.

Fourth, predefined exit mechanisms are key to enforcing market discipline. Governments cannot reliably predict winners, so some interventions will fail. Policy implementation should incorporate sunset clauses to ensure that support is withdrawn from underperforming projects or projects for which the reasons for intervention no longer hold. Without credible termination mechanisms, temporary interventions risk becoming permanent, trapping resources in unproductive uses.

Fifth, industrial policy underscores the importance of structural reforms. With finite institutional capacity, industrial policy risks crowding out structural reform. Yet without structural improvements, interventions will underperform. For example, subsidising high-tech sectors will fail if fragmentation prevents firms from reaching minimum efficient scale. Advancing the savings and investments union, easing labour market rigidities and reducing burdensome administrative work would help mobilise private risk capital across borders. These conditions enable capital and labour to be reallocated from declining firms to productive sectors – a market mechanism industrial policy cannot replace.

5 Conclusion

Industrial policy can play a role within the broader policy framework, provided interventions are well designed, targeted and time limited. The macroeconomic impact of interventions is context dependent. In the EU’s multi-country Single Market, with its heterogenous institutions and bank-based financial structures, uncoordinated national measures risk fragmenting competition and triggering subsidy races. To be effective, industrial policy needs a clear mandate, robust governance, market-based incentives and mechanisms for continuous evaluation. Interventions should be time limited by design, with support for capital-intensive activities conditional on predefined milestones, targets and exit criteria.

Even with institutional safeguards, industrial policy entails macroeconomic trade-offs. Where the goal is productivity, industrial policy can be most effective when fostering innovation and supporting the adoption of frontier technologies rather than shielding incumbents from competition. Where the goal is resilience, policymakers need to weigh the insurance value of reducing dependencies against the costs of allocative inefficiency. In all cases, sector-specific intervention is only one element of a broader set of policy measures; it cannot substitute structural reforms that improve the framework conditions for potential growth.

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