Refocus PLI towards exports

Wider reforms, not picking winners are the answer

Industrial policy is back. Countries around the world are using a variety of instruments to foster specific industries. An extensive historical review shows that over the past 25 years, industrial policy, or IP1, has been alive and well all over the world, and especially in the richer Organisation for Economic Co-operation and Development countries. 

The share of government interventions that could be classified as IP has gone up from around 5 per cent in 2010 to an average of over 40 per cent today. IP now covers not just industry but even the service sector, and whereas earlier it was directed mostly at larger firms, today it can even cover small and medium enterprises (SMEs). It is the flavour of the day. 

Recent studies2 on IP argue that the state’s capability and its relationship with the private sector are critical in making IP successful. If a state tries to do too much — without adequate state capability — it is less effective. (see graph). 

For any level of government capability, there is an optimal level of government activity. It is like a Laffer Curve for tax revenue, where revenue rises as taxes rise but up to a point. If the tax rate is too high, revenues fall. Similarly, if the state tries to do too much for any level of capability, its effectiveness initially rises but then falls. There is an optimal level of the scope of state intervention for every level of state capability. For lack of another name, I call this the “Chhibber Curve” of state effectiveness. When a state has over-reached, then doing less  — moving from A to B  —  will improve the effectiveness of the government. Over time, as state capability improves, the scope of state actions can go up and move from B to C. 

Government actions can be classified into three categories. Under Category 1, we have minimal functions such as defence, law & order, and public health. Many developing countries are unable to even do these minimal functions competently. The next level, Category 2, is intermediate functions, such as education, environmental protection, encouraging research & development (R&D), financial and utility regulation, and provision of social insurance. Some of these activities, such as encouraging R&D, are sometimes also called a lighter version of IP. Finally, in Category 3 we have a more activist role for the government in coordinating private activity — fostering markets and cluster initiatives. These more activist functions were traditionally considered IP. 

If the state is unable to provide services under Category 1 and 2, such as basic health, and is underfunding education, or failing to implement measures for environmental protection, or provide proper health insurance to citizens, it’s not likely to be a great candidate for more activist policies under IP. 

States with weaker capabilities must first perform basic and intermediate functions under Categories 1 and 2 before they jump to more activist IP policies. They can support industry but with simpler options like better education and training, encouraging R&D through tax incentives, providing support for industrial parks, and building public infrastructure, but should not get into the more activist “picking” winners for support. 

To address the second problem with IP — the relationship between the state and private sector, scholar Peter Evans argued that countries that succeeded in IP had “embedded autonomy” i.e., the government worked closely with the private sector, yet was independent of it. But in practice this is an oxymoron. 

The key to successful IP is the design of performance indicators to receive IP benefits. The successful East Asian countries, Korea and Taiwan, used quite different instruments under IP and targeted diverse types of firms. In Korea’s case, support was targeted to industries with large Chaebols versus Taiwan, which supported industries where SMEs and state-owned enterprises predominated. But in both cases, IP was successful because the yardstick of performance was exports, which ensured that firms receiving IP support had to be internationally competitive. IP benefits were also, at least in Taiwan’s case, not targeted at “selected” firms but more widely at the industry. 

India is not a great candidate for IP as it is not even adequately providing the basic functions of a state — such as public health and education and scores low on state capability indices. There is also evidence of regulatory capture, especially in telecom. In the Berggruen Governance Index, India’s state capability has declined since 2013 despite the promise of “Maximum Governance and Minimal Government”. 

India tried IP before in the period 1950-1990 through import substitution and state-owned enterprises called public-sector units. But that IP era failed miserably. It has nevertheless ventured into IP through its production-linked incentive scheme, where subsidies are provided to 14 industries. But the PLI subsidy is linked to incremental production and sales rather than to export performance. 

Fortunately, so far, the PLI scheme has shown success in iPhone assembly and pharmaceuticals, where the gains have come through exports. Large scale electronics manufacturing and pharmaceuticals — where the subsidy is not even needed — accounted for 73 per cent of total PLI incentives disbursed till FY26. 

Disbursal under other industries such as IT hardware, telecom, automotive, ACC battery, and solar PV modules have been limited. In some of these industries, the objective is import substitution, not exports, and there is no way of judging if it will succeed and at what cost. Moreover, these industries will clamour not just for subsidy but also more import protection. Hopefully, the flurry of free trade deals India is trying to reach will limit these. 

India needs to focus its scarce public resources on education and public health, not on costly PLI schemes to pick “winners.” It must limit the damage by focusing PLI subsidies on exports, putting a hard stop on them, and focusing instead on wider reforms to make industry more broadly competitive and not dependent on IP subsidies.

The writer is distinguished visiting scholar, Institute for International Economic Policy, George Washington University 1. Juhász R, Lane N, Oehlsen E, Pérez VC. 2022. 

The who, what, when, and how of industrial policy: A text-based approach. https://tinyurl.com/mr3maeyv  2. Fernandes & Reed, Industrial Policy for Development: Approaches in the 21st Century, World Bank Policy Research Report, 2026;  Mazzucato & Rodrik, Industrial policy with conditionalities: a taxonomy and sample cases, Industrial and Corporate Change, 2026