Perspectives on Industrial Policy: An Interview with Reiko Aoki

Today’s industrial policies are closely tied to security concerns. National security, in particular, has always required some form of government coordination, whether through resource allocation via budget plans or broader strategic initiatives, often abstract in nature. Governments are expected to provide national security, and it is widely accepted that they should play a role in ensuring it. Economic security has also gained prominence due to recent supply-chain disruptions, particularly in the wake of the COVID-19 pandemic. To mitigate future disruptions, there have been increasing calls for government coordination. Additionally, disruptions driven by geopolitical concerns have become more relevant than ever.

Beyond national and economic security, another key factor shaping industrial policies is competitiveness. Countries seek to enhance their global standing by fostering firms that can compete internationally. This translates into gaining the ability to exert market power in global markets, which can sometimes lead to problematic outcomes.

Japan has had an industrial policy since its post-World War II recovery focused on investing in infrastructure, boosting productivity, and increasing per-capita income. This policy required targeted and coordinated investments in key intermediate goods industries, such as steel and chemicals. The overarching goal was to catch up with OECD economies by building the necessary infrastructure and industrial base.

As you note, in Japan, we’ve observed a historical approach of supporting national champions. Could you explain the shift from policies favoring national champions toward encouraging competitive markets? And what lessons does this provide for policymakers today?

While Japan was playing catch-up, we also observed that its approach initially favored national champions before shifting toward encouraging competitive markets, an important baseline for policymakers today. Catching up meant that the goal was to develop an industrial structure similar to that of OECD countries. This involved building key industries such as steel, chemicals, automobiles, electronics, and pharmaceuticals, with clear targets for industrial development.

Today, many Japanese firms are globally competitive, and they largely originate from industries that once benefited from industrial policy. These firms became competitive, however, through market processes rather than direct government designation of a national champion. Resources were allocated to industries, rather than to individual national champions. There was also the concept of excess competition, which made sense in industries with high fixed costs.

In most cases, however, multiple firms were competing within the same sector. For instance, the automobile and electronics industries saw strong competition and, while some firms emerged as obvious national-champion candidates, they were not explicitly designated to become national champions or globally dominant players. Instead, their success was driven by market forces.

Catching up also meant that there were several obvious steps the government could take. Technologies were available for licensing from abroad, and license-fee levels were restricted. The number of places for engineering students in national universities was increased to build capacity to adopt new technologies. Additionally, because the financial market was underdeveloped, the government intervened to some extent. In fact, the original purpose of the Subcontract Act was to address the lack of short-term credit.

Now, however, the Japanese economy can no longer rely on importing new technologies for adoption. It is not even clear on which industries Japan should focus its resources. In such a scenario, a competitive market can efficiently allocate resources where they are most needed. A well-functioning market also allows for a more efficient use of subsidies. The focus should be on improving market efficiency, particularly in labor and financial markets.

Would it be fair to say that early Japanese industrial-policy interventions were more effective because the markets were less developed, allowing imported technologies to yield rapid benefits, whereas similar interventions today would face diminishing returns and higher costs?

That’s correct—Japan now resembles other OECD countries, so traditional industrial-policy measures are no longer effective or necessary. We need to be cautious when implementing policies that overly protect incumbent firms, as they can capture industrial policy to their advantage. Protecting incumbents effectively stifles dynamic competition. A perfectly competitive market requires free entry and exit, but excessive protection of incumbents or barriers to new entrants result in the exertion of dynamic market power. This reduces consumer choice, discourages innovation for both existing and potential firms, and prevents cost reductions and product-quality improvements. In such cases, industrial policy becomes a tool for deterring domestic competition, rather than fostering a healthy market.

Essentially, this policy was relevant when Japanese markets were still developing. At that stage, there was room to import technologies and acquire know-how, making early government intervention relatively low-risk. As the economy has matured, however, the returns on such interventions have diminished, while the costs have increased. This approach no longer works. Today, Japan functions as an OECD country, and the old industrial-policy strategies are no longer necessary.

Your research highlights how intellectual-property rights interact with innovation and competition. How should policymakers treat IP protection to foster innovation, without creating barriers that harm overall market dynamism?

We are seeing how intellectual property increasingly interacts with innovation and competition. A case-by-case enforcement approach is essential. IP should not be used to extend market power to the next generation of technologies or products. While IP protection lasts for several years, it should only safeguard the original technology. Although this creates some static inefficiencies, it is justified by the need for dynamic efficiency, where new technologies are excluded, but not those that build upon the original invention. Some form of compensation for the original technology is reasonable, but firms often use bundling and other strategies to extend IP protection beyond its intended scope, leading to entry deterrence or foreclosure.

Intellectual property law does not differentiate among the innovations it protects. For instance, all patents have the same duration of protection, even though product lifecycles vary significantly. This variation depends not only on patent protection but also on the nature of innovation in different industries. Firms in different sectors use IP in various ways to safeguard their market positions and profits. Enforcers must, therefore, analyze the effects of IP on competition on a case-by-case basis.

For example, in the pharmaceutical industry, patents are used for “pay-for-delay” strategies, while in the semiconductor industry, they play a different role in licensing. Research has shown that the importance of patents for profit protection differs across industries. Over time, the role of IP has evolved due to changes in patent policies, technological advancements, and shifting market conditions. This further underscores the need for a case-by-case enforcement approach.

Trade agreements today often integrate competition and IP provisions. How do you see international trade policies evolving to better handle the complexities of global innovation and competition?

Countries are increasingly incorporating provisions related to intellectual property and competition into trade agreements. The extent to which these agreements include such provisions does, however, vary significantly. For instance, the GATT Uruguay Round introduced the Trade-Related Aspects of Intellectual Property Rights (TRIPs) agreement, which led to the harmonization of patent systems worldwide, including in the United States.

In contrast, competition policy has not seen the same level of integration. In Japan, for example, the TPP-11 agreement introduced a commitment system in the enforcement of the Anti-Monopoly Act (AMA), but its scope was limited. Recent research has shown that, in East Asia, the adoption of competition policies and enforcement systems often occurs in the years leading up to a major free-trade agreement. This suggests that trading partners seek well-functioning markets for both selling products and sourcing intermediate and final goods. Any distortion that creates a gap between price and cost is detrimental to producers and consumers alike, both domestically and globally.

In this sense, trade agreements serve as a form of competition enforcement in international markets. Looking ahead, international trade policies may need to evolve further to better address the complexities of global innovation and competition.

Given that Japan’s patent system encourages incremental innovation and India’s stricter patentability criteria may reduce overall incentives for incremental R&D, what key lessons can other countries draw from these contrasting models when shaping their own IP and industrial policies?

Intellectual property should not be used as a tool for industrial policy. While patent systems are often tailored to domestic industries—Switzerland’s approach to watch patents being a notable example—IP protections should not be selectively applied to shield incumbents in specific sectors.

The incentive to litigate patents is largely determined by the value and size of the market. Private litigation reflects this dynamic. While some argue that patent litigation imposes social costs, the allocation of resources for IP protection is more efficient when left to market forces, rather than being dictated by policy. This ensures that IP enforcement serves its intended purpose without distorting competition.

Given the rise of economic nationalism in recent years, what key challenges must trade advocates tackle to maintain the sustainability and political viability of global trade?

The most important step is to keep explaining and making the case for trade. Most countries cannot achieve acceptable living standards without engaging in trade. These nations must work together to sustain trade relationships, at least among themselves. Comparative advantage cannot be ignored; those that participate in trade will ultimately be better off.

Greater attention must also be given to the redistribution of trade gains. This requires smart taxation policies that ensure fair distribution without distorting market efficiency. Allocating trade rights through patronage should be avoided, as it only exacerbates inequalities in the benefits of trade.

Many people use welfare theorems to justify competitive markets, but Kenneth Arrow also emphasized the importance of income distribution. He was deeply concerned about the fact that market equilibrium does not inherently address distributional issues. Free markets do not solve everything; income distribution remains a critical problem. We should pay closer attention to the Second Welfare Theorem, which suggests that multiple competitive equilibria exist, some of which can lead to highly unequal outcomes. By reallocating resources appropriately, societies can move toward more equitable equilibria, while still allowing markets to function efficiently. The key is to reach a political consensus on what constitutes an acceptable equilibrium. Once that is established, markets can do the rest. This fundamental principle is often overlooked.

So, even if an economic system produces one optimal income distribution, political dissatisfaction with that distribution can create practical problems that undermine the theoretical benefits of a perfect trade equilibrium?

Yes, and we should pay further attention to the Second Theorem. As we know, there are many competitive equilibria. And some are going to be terrible—where one person will own everything, for instance. But then there are ones that are more “equal” but are also perhaps more politically palatable. The Second Welfare Theorem says that, by reallocating resources, you can achieve any equilibrium that you want. Thus, politically, you can agree on which is a more acceptable equilibrium and then reallocate resources so that the market can function, which allows you to achieve maximum efficiency, as well as an acceptable income distribution. Often, we forget that’s what the Second Theorem says.