There is a certain seductive logic to watching your rival gain advantage through state support and concluding that you should respond in kind. Across the American political spectrum, from think tanks like the Information Technology and Innovation Foundation to conservatives who once treated “picking winners” as a term of derision, industrial policy has staged a remarkable comeback. The pitch is straightforward enough: if Beijing is subsidizing its way to dominance in semiconductors, electric vehicles, and advanced manufacturing, surely Washington cannot afford to stand on free-market principle while the factories disappear. It is a compelling story, and it is also, on closer inspection, largely a myth.
For all the alarm generated by China’s industrial ambitions, the evidentiary base for the enthusiasm is surprisingly thin. Rigorous evaluations of whether Chinese industrial policy has actually worked remain scarce, a striking gap given the scale of resources involved. When researchers have finally attempted to take the full measure of it, what they find is not a juggernaut of state-directed efficiency but rather an expensive disappointment.
The sheer scale of the Chinese industrial policy apparatus is not in dispute. Spanning cash subsidies, tax breaks, subsidized credit, and below-market land for favored sectors, it carries an estimated fiscal cost of around 4.4 percent of GDP as of 2023, with the dominant instrument being cash subsidies at 2.0 percent of GDP, followed by tax benefits at 1.5 percent, land subsidies at 0.5 percent, and subsidized credit at 0.4 percent. For comparison, EU state aid across the same instruments ran to roughly 1.5 percent of GDP in 2022, with large manufacturing economies sitting slightly above that average. China, in other words, is not merely doing what Europe does with greater enthusiasm; it is doing it at roughly three times the intensity.
The question that follows naturally is what three times the intensity actually buys. According to research, factor misallocation from these policies reduces domestic aggregate total factor productivity by about 1.2 percent relative to a no-industrial-policy baseline, with the knock-on effect of dragging GDP down by up to 2 percent. The policies engineered to supercharge the Chinese economy are, quietly and persistently, undermining it from within. One might at least hope to find some compensating dividend at the firm level, some evidence that the chosen champions became genuinely more productive as a result of state backing. There is none. No statistically significant relationship exists between industrial policy intensity and average firm-level total factor productivity within the same sector, under any specification tested. The innovation prize that industrial policy advocates most reliably promise simply does not appear in the data.
To understand why these outcomes emerge, it is worth examining the precise mechanism by which industrial policy distorts resource allocation, because it cuts against the intuitions of many of the policy’s most enthusiastic admirers. The analysis relies on a structural model built around total factor productivity in revenues, essentially a measure of how efficiently firms deploy their inputs relative to the returns they generate. In a functioning market, factors of production flow toward their most productive uses, and the gaps between firms narrow over time as competition does its work. Industrial policy disrupts this process in two distinct and opposing directions simultaneously, which is precisely what makes it so difficult to correct once entrenched. On one side, subsidies are associated with excess production beyond what a no-distortions benchmark would produce; on the other, trade and regulatory barriers restrict output, likely by increasing the market power of incumbents who can then limit supply, charge higher prices, and capture rents at the expense of consumers and downstream industries. The result is not a coherent industrial strategy so much as an economic tug-of-war, with different policy instruments pulling the economy in opposite directions rather than toward any coherent optimum.
The damage, moreover, does not remain neatly contained between sectors. Within individual industries, the dispersion of productivity outcomes across firms is measurably wider in sectors subject to industrial policy than in those without it, with a statistically significant 14 percent higher within-sector productivity dispersion in affected sectors. Taken together, industrial policy accounts for around 24 percent of between-sector productivity dispersion and around 4 percent of within-sector misallocation. The between-sector figure is the more sobering of the two, because it is precisely where industrial policy is most deliberately active, redirecting capital and labor across the economy toward government-favored industries rather than those generating the highest returns.
Nothing in the pro-industrial policy narrative carries more rhetorical force than the spectacle of the national champion, the dominant domestic firm in a strategic sector that appears to vindicate the entire model of state-directed capitalism. The research, however, has considerably less flattering things to say about these celebrated enterprises. Leading firms do tend to exhibit higher productivity than the average firm in their sector, though this is more or less what one would expect even without any government involvement whatsoever. Far more revealing is that these same leaders typically exhibit lower revenue total factor productivity than the sector average, implying they are producing at inefficiently high levels relative to the returns they generate, and this pattern is particularly pronounced among state-owned enterprise leaders. Their scale reflects not merely competitive excellence but the accumulated distorting effects of subsidies, credit guarantees, and preferential resource access, an artificial inflation of size well beyond what genuine productivity alone would justify.
For a ground-level illustration of how this plays out in practice, China’s shipbuilding sector offers what is perhaps the most vivid and instructive case study available, combining extraordinary fiscal commitment with outcomes that fall conspicuously short of the ambition. Between 2006 and 2013, the Chinese government channeled the equivalent of RMB 624 billion, roughly $91 billion, into the sector through entry subsidies, production subsidies, and investment subsidies, with entry subsidies alone accounting for RMB 431 billion of the total, dwarfing the RMB 156 billion directed at production and the RMB 37 billion at investment. These were not marginal interventions nudging an industry in a preferred direction; they were transformative injections of public money that reshaped a global industry, and the question is whether the returns justified the cost.
The evidence suggests they did not. When the lifetime profit gains of domestic firms are measured against the total subsidies disbursed, the gross return rate stands at just 18 percent. For every yuan spent supporting the sector, domestic producers gained fewer than twenty fen in net profit, a result substantially depressed by the fixed costs that shipyards must bear regardless of whether any vessels are actually being built. Those fixed costs were calibrated at RMB 15 million per quarter per firm, equivalent to approximately 12 percent of average industry profit, and even in a hypothetical scenario where fixed costs were zero, the rate of return would have risen only to 25 percent, still far below what the scale of public expenditure might reasonably have been expected to generate.
These policy-level failures are compounded by deeper structural weaknesses within the Chinese economy that rarely feature prominently in the Washington conversations about what America might learn from the Chinese model. China’s technological capabilities, while impressive in certain areas, remain predominantly at an intermediate level, sitting between 4 and 7 on a scale of 1 to 10 in applied technology and falling well short of the higher-order innovations that define genuinely advanced economies, with a significant and persistent reliance on foreign core technologies and key components meaning that China’s overall technological system, for all its visible strengths, is neither comprehensive nor self-sufficient.
The Chinese experience represents the largest and longest-running industrial policy experiment in the modern era, prosecuted with vast administrative resources and an authoritarian government’s unrivaled capacity to direct capital, and what decades of effort at this scale actually reveal are costs that are real, measurable, and significant. The misallocation it generates is not a rounding error on an otherwise successful ledger but a structural drag on the very economy the policies were designed to strengthen. Before Washington rushes to build an industrial policy apparatus modeled on China’s example, it ought to reckon honestly with what that example actually demonstrates, because the mirage of the Chinese model is visible and compelling from a distance, and it dissolves consistently on close inspection.
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