Beware of Industrial Policy | Episode 89 | Everything is Everything

Notes

The 500 dollar bill and the impossibility of planning

The episode opens with Amit recounting a fan email that praised the show effusively before suggesting that Ajay and Amit should be running the country's economy. Amit uses this as a launchpad to lay out three objections. First, running a YouTube show well does not qualify anyone to run a country; a country is far too complex for that kind of transferred competence. Second, power corrupts, and Amit credits his own lack of power and his share of setbacks in life for preserving whatever humility he has. Third, and most central to the episode, is Amit's discomfort with the word "plan" itself.

Amit invokes Friedrich Hayek directly:

"Planning a country is just a conception of great hubris. Our hero Friedrich Hayek called it the fatal conceit. It simply cannot be done. A nation is too complex. And that kind of top-down thinking leads us to ruin again and again."

Ajay follows with two personal stories that ground this abstract point in lived experience. As a "callow thirty-five year old" freshly hired by then Finance Minister Yashwant Sinha, Ajay expected to find obvious mistakes and low-hanging fruit in policy. Instead he found the job "very, very hard," with no easy five-hundred-dollar bills lying on the ground. His second story is about sitting in a meeting run by Chief Economic Advisor Ashok Lahiri, where the Ministry of Commerce would routinely set a target for India's exports. Ajay recalls objecting even as a junior voice in the room:

"Excuse me, what does the Ministry of Commerce or any of us have to do with what India exports? India is a collection of people, and those people export. The Indian state has essentially nothing to do with the exporting decisions or the exporting success of individual firms."

Amit extends the metaphor of the "500 dollar bill" into a comic parable about a rational-markets economist who refuses to pick up money on the street because he assumes it must be fake, contrasted with a content-hungry YouTuber who gets outmaneuvered entirely. Underneath the joke is the episode's real target: the assumption that smart people sitting in Delhi can out-think a decentralized economy.

What is industrial policy?

Ajay defines industrial policy precisely: it is the practice of a government picking winners. This can mean favoring an industry over another, a technology over another, a specific firm, or even a place of production. The examples are everywhere in the machinery of Indian government, from the Ministry of Textiles to the Ministry of Chemicals to the Ministry of Steel.

A key illustration is the phenomenon of industrial clusters, like Tirupur for garments or Gujarat for chemicals, or globally, Silicon Valley. These clusters emerge organically, driven by network effects, skilled labor pools, and vendor ecosystems. The danger, Ajay argues, is when governments look at a successful organic cluster and conclude they can manufacture one by decree. This is the moment public policy crosses the line into industrial policy.

Ajay is careful to distinguish between clusters evolving with public policy inputs in the background, which he says he will return to later in the episode, and governments actively trying to will a cluster into existence, often for reasons unrelated to economic logic:

"There's a powerful politician who has a constituency who will announce that no, I want a garment cluster. So the government will start saying, "Yeah, we will make a garment cluster happen." And again, we should be very skeptical about all this."

Amit connects this back to the show's recurring theme about firms being the fundamental unit of economic growth. GDP is the sum of value added by all firms in a country, and growth happens because entrepreneurs solve each other's problems in countless "double thank you moments." The government's proper role, in Amit's framing, is to provide rule of law, enforce contracts, and otherwise get out of the way, not to act as a central planner deciding what gets built and where.

Ajay reinforces this with the arithmetic of GDP: a rich country is one filled with high-productivity firms, and a poor country has the same people producing at low productivity. The task of development is entirely about raising that productivity, and nothing about geography or ethnicity condemns any country to permanent low productivity.

"Indians are not inferior. Sundar Pichai is an Indian, Satya Nadella is an Indian. So there's nothing wrong with Indians. What is wrong is with the incentive structure."

How industrial policy works: the four levers

Ajay lays out a four-part taxonomy of how governments actually attempt industrial policy in practice.

Lever one: subsidies. This covers any use of public money to favor a chosen industry or firm, whether through direct payments, tax breaks, or indirect input subsidies. The example given is a hypothetical beef export cluster subsidized directly, or a tax break for the software industry.

Lever two: coercive power. Here the government does not spend money but instead uses regulatory force to favor certain technologies or industries. Ajay cites a concrete example from Suyash's research: the government's use of income tax law to fine shopkeepers who don't accept UPI, effectively using coercion to entrench a chosen payment technology. He contrasts this with the US government's release of GPS technology for public use, which spread through voluntary adoption with zero coercion involved.

Ajay also shares a memorable historical anecdote about RBI's rules on External Commercial Borrowing, once restricted to just nine specific industries:

"The chosen industries were nanotechnology, poultry farms. Poultry farms are very important... Chicken needs cheap credit. So we will give exclusive access to external commercial borrowing to poultry farms."

Lever three: ethno-nationalism. This is the practice of favoring Indian firms simply for being Indian, and disfavoring foreign firms. Ajay flags the definitional problem immediately: what even counts as an "Indian firm" when ICICI Bank is 90% foreign-owned, or when Microsoft has an Indian CEO. He argues the opposite policy would actually serve India better, since foreign firms carry the world's most advanced productivity knowledge, and their presence in India helps that knowledge diffuse locally.

Lever four: government monopolies. This is the most extreme lever, where the government gives up trying to shape private markets and simply becomes the entrepreneur itself, creating a state monopoly like Air India, UPI, UIDAI, or Bharat Bill Pay.

Amit observes that in doing this, the government is trying to simultaneously play two incompatible roles: venture capitalist (lever one, deciding where money should go) and entrepreneur (lever four, directly building the business). Both roles work in a market economy only because there are many competing venture capitalists and many competing entrepreneurs, most of whom fail, allowing the best ideas to emerge through competition and creative destruction. A single centralized decision-maker cannot replicate that process.

Ajay closes the chapter by describing the "socialist trap": once officials amass power, they get cut off from real knowledge because everyone around them just tells them what they want to hear, which makes them more confident even as their information gets worse, fueling a cycle of ever more control.

Subsidies in depth

Ajay opens by asking why the government needs to give subsidies at all when finance already exists to fund promising opportunities. If poultry farms are genuinely a great investment, private investors can buy shares or extend loans; there's an entire global and domestic financial system whose job is constantly scanning for the next good opportunity.

"Finance works through failure. It is just magical. The financial system throws money after dozens and dozens of long shots, and some of them work, most of them fail. That's the glory of finance."

The objection that India's financial system is underdeveloped is acknowledged, but Ajay insists the correct response is to fix the financial system's root problems (a subject covered in the show's episodes on the beauty of finance and the journey of Indian finance) rather than have the government try to replace finance with subsidies.

The chapter then turns to why public money is fundamentally different from private capital. Taxation, Ajay says, "has blood on it." People distort their behavior to avoid taxation, and that distortion carries a real productivity cost, on top of the overhead of compliance, litigation, and enforcement. This leads to the concept of the marginal cost of public funds (MCPF), estimated at roughly three: every rupee the government extracts and spends imposes about three rupees of cost on GDP. This is why public money should be reserved for clear public goods and market failures, like defense or smallpox immunization campaigns, where the return can plausibly exceed that cost. Subsidies to poultry farms or textile companies, in Ajay's view, essentially never clear that bar.

Amit connects this to a broader principle he holds: every market intervention amounts to a redistribution of wealth from the poor to the rich, since the costs of subsidies are dispersed and invisible while the benefits are concentrated in politically connected firms. He brings in Milton Friedman's four-way matrix of spending (own money on yourself, own money on others, others' money on yourself, others' money on others) to argue that government spending, being others' money spent on others, is structurally the worst-incentivized form of spending, since it optimizes for neither economizing nor value.

The chapter also brings in public choice theory to explain why government officials are worse at capital allocation than financial markets. Because officials aren't personally accountable for investment outcomes the way fund managers are, they have little incentive to build real expertise, and they are systematically flattered and misled by industries lobbying for favors.

"In finance, it's a cold, merciless environment of devoting very smart people and resources to obtain information, to buy research, to form a view of the world, to put your money where your mouth is and be judged and held accountable for how well those equity and debt investments work."

Ajay closes with a caution aimed at private-sector engineers and entrepreneurs who are quick to call for government intervention in industries they personally believe in, like lithium-ion batteries. His warning is twofold: being a smart private investor doesn't mean state power should back your chosen technology, and being knowledgeable doesn't mean you'll be the one making the decision inside government.

"Don't assume that you are the guy who will be that joint secretary. People make the mistake that I am so smart, I am so good, I know what's right for the world, bracket, you don't. And second, I'm the guy that will be the joint secretary, bracket, you won't."

Amit adds a cultural diagnosis: in a protected Indian economy, the path to success has often run through influencing bureaucrats and securing favorable policy rather than competing globally on value, which breeds a rent-seeking mindset distinct from economies where success comes from serving customers directly.

The folly of PLI

The discussion turns to India's Production-Linked Incentive (PLI) scheme, using Apple's operations in India as the central case study. Ajay lays out a genuinely sympathetic reading first: India's indirect tax system contains real mistakes that distort investment decisions disproportionately, since the average non-financial Indian firm's profit-after-tax margin is only around 6%, meaning even small tax errors of 1-3% can swing return on equity by 50-100%. On this reading, PLI-style payments to Apple can be understood as a correction for bad indirect taxation, since no country should tax goods that are imported, processed, and re-exported.

But Ajay raises several serious concerns. First, if the underlying problem is bad tax policy, the correct fix is to repair the tax system directly rather than run a permanent subsidy scheme to compensate for it, since PLI does not address the root cause.

Second, and more pointedly, he argues the "win" of getting Apple to operate in India sets the bar too low:

"Apple is an enormously powerful firm. They have the resources to hire a high-quality policy team in Delhi... Most global firms are either small or are not sufficiently committed to India to bother."

The implication is that a deals-based approach benefits only firms large enough to negotiate directly with government, while thousands of smaller global firms who would otherwise invest in India are locked out by the same underlying structural problems that Apple had the resources to negotiate around.

Third, Ajay draws a sharp line between legitimate "disabilities" (bad tax policy that should be refunded) and illegitimate ones that businesses often try to claim, like expensive transportation, unreliable electricity, or unskilled labor. He argues government should never compensate for these:

"No government should pay a shred of attention to all these kinds of claims. Producing everywhere in the world is a mixed bag... Don't whine to the government saying, "Oh, it's so difficult to operate in Silicon Valley because the rents are high." There is no role for a government to overcome input prices."

He points to India's genuinely low labor costs as a major built-in advantage, and argues the real puzzle is why India doesn't export far more than it does, a point he credits to Rahul Ahluwalia. The solution to that puzzle, in his view, lies in fixing deep structural problems, not in offering more subsidies.

Coercive power

Moving to the second lever, Ajay explains why government coercion around technology is even more dangerous than subsidies, since coercive power carries no budget constraint. He revisits the UPI example, where income tax law is used to fine retailers who don't accept the state-favored payment technology.

The core argument here is epistemic: nobody in government can look at the complexity of the economy and correctly choose the winning technology, and worse, the market economy actually benefits from having multiple rival technologies competing and evolving rather than one anointed standard.

"Standards wars are a great thing. Multiple rival standards battling it out for supremacy is a very good and healthy thing to have in the world."

Ajay draws a distinction between the engineer's notion of "technology" (the machine itself) and the economist's notion (the entire complex of technique, process knowledge, and tacit organizational learning around using that machine). His analogy is military: giving an army good tanks doesn't make it a world-class fighting force, because success depends far more on management complexity, human knowledge, and how well people work together than on the hardware itself. He connects this to the show's earlier episode on Moore's Law and Wright's Law, and to the broader theme of firm internationalization, arguing that tacit knowledge is transferred through people who have worked inside great global firms, not through machines alone.

Amit adds that technology itself is a constantly moving target, obsolete almost as fast as it appears, which makes government attempts to lock in a "winning" technology especially futile, since real innovation depends on ongoing ferment and improvisation rather than static cutting-edge status.

Ethno-nationalism

The third lever, ethno-nationalism, includes protectionism and any policy that uses state coercion to disadvantage foreign firms in favor of domestic ones. Ajay says he cannot imagine a coherent mechanism by which reducing competitive pressure on Indian firms would make them better.

"India is a poor country. A poor country is one with low productivity firms. The advanced economies of the world have high productivity firms. The tacit knowledge, the explicit engineering knowledge is all in those firms. When those firms operate more freely in India, then that kind of knowledge will diffuse all over the Indian landscape."

He carves out one explicit exception: national security. The Indian army has legitimate reasons to worry about backdoors in Chinese equipment given the volatile Himalayan border situation, and it makes sense for the military to secure a trusted component supply chain. But Ajay is careful to say this does not justify distorting the entire civilian economy, and that even in defense, full self-reliance may not be optimal since partnerships (as seen with Ukraine's drone industry avoiding Chinese parts) may be a wiser path than trying to build everything domestically.

He also links this back to geopolitics broadly, arguing that the single best path to military and foreign policy strength is high GDP growth, illustrated by the observation that Russia's GDP is roughly the size of Italy's, which makes its standoff with a much richer Europe fundamentally more manageable than it might otherwise be.

Amit follows with his own explanation of why protectionism is doubly harmful: the seen effect is that a protected domestic firm appears to benefit, but there are two unseen costs. First, wealth is redistributed from consumers (often the poor) to the protected firm, since costs are dispersed and invisible while benefits are concentrated. Second, and more insidiously, the protected firm itself loses the competitive pressure that would have forced it to improve, trapping it in a low equilibrium rather than helping it.

Government monopolies

The fourth and most extreme lever is when government abandons the pretense of shaping private markets and simply becomes the business itself, creating a public sector monopoly. Ajay frames this as the bureaucrat's last resort after subsidies and coercion fail to produce the desired industry:

"First you have a PSU, the PSU does badly, then you start harming the private companies, then you just go to saying this is my monopoly."

He notes this is not a relic of pre-liberalization thinking but an ongoing pattern, citing historical examples like UTI (mutual funds), LIC (insurance), and Coal India, and noting that new state monopolies continue to be created today, with coercive power then deployed to protect them and turn them into "national champions."

Amit brings in his own vivid pre-liberalization memories: seven-to-eight-year waiting periods for a telephone under the MTNL monopoly, and airline tickets so expensive that even an IAS officer's family could rarely afford to fly. Both sectors transformed dramatically once competition was allowed after 1991, illustrating how quickly monopolies become irrelevant once genuine competition is introduced.

The Air India story serves as the chapter's central case study: a private airline built by the Tatas, expropriated into a government monopoly, later opened to competition, and eventually returned to the Tatas after the state-run version was burning through an estimated 35,000 crore rupees a year in taxpayer subsidy just to stay operational.

"It was a zombie firm that only by continuous injection of taxpayer resources... of our money... was Air India kept aloft."

Ajay reflects on the tragedy of the detour: had Air India simply remained private and the Indian airline industry stayed open to multiple global rivals throughout, the decades of state intervention and subsidy might never have been necessary at all.

The China question

Addressing the common objection that China's industrial policy has clearly worked, given its success in EVs and solar photovoltaics, Ajay offers a two-part response. First, he argues there is an element of cherry-picking in pointing to a few winners while ignoring the broader landscape of failures produced by the same system of state control.

Second, and more importantly, he argues the full picture of Chinese industrial policy includes serious costs that must be weighed against the visible successes. He points to China's property market, where there are roughly 1.5 apartments for every household, an oversupply Ajay says is effectively impossible to resolve given China's declining population trajectory.

"Who is ever going to resolve that mess? Because they have no hope of ever having 50% more people. They are on a negative population growth trajectory. That is also to be laid on the doorstep of the industrial policy of the central planners."

Ajay invokes a variation on Tolstoy's opening line from Anna Karenina: all successful advanced economies look alike, while unhappy, poor countries fail in their own idiosyncratic ways. China's property overhang, in his framing, is a distinctly Chinese malaise produced by a distinctly Chinese level of state domination, not evidence that industrial policy is a generalizable path to prosperity. He extends this to note that China's per capita GDP remains far below that of advanced economies, and that the loss of economic dynamism since Xi Jinping's consolidation of power is itself a cost that should be attributed to the same industrial policy framework being praised for EVs and solar.

What should the state do instead?

Returning to the fan email's original provocation, Ajay lays out a positive vision built around a single guiding phrase: the job of policy is to enable winners, not pick them.

He argues that hidden inside the private sector are countless potential high performers, and government's role is to create the conditions in which winning can happen, without knowing in advance who will win. This translates into a few concrete areas of state action:

Research and higher education: Public money can fund extremities of scientific and engineering knowledge in universities and through contracts with private firms, done in an industry-neutral way, funding both nanotechnology and, half-jokingly, better egg production, rather than the government choosing which industries deserve support.

"There is no conceivable benefit to humanity, but by challenging those private firms, we're creating knowledge. And then some of those private firms will turn around and say, "Oh, I can make better spectacles for Amit using this technology." You can't predict where knowledge will go."

Competition and creative destruction: Government should focus on making it easier to start firms, attracting venture and foreign capital, breaking up cartels and entry barriers, and enabling smooth bankruptcy, so that firms face constant competitive pressure to improve rather than being protected from it.

Internationalization: A successful economy imports and exports more, and Indian firms should be free to become multinationals organically, without government-imposed friction from bodies like the Enforcement Directorate or restrictive company law. Global firms should be able to operate in India on a level playing field

Immigration: Ajay argues India should ease its visa and immigration procedures so that Indian firms can recruit globally rather than being limited to a purely domestic talent pool, connecting this to the show's earlier chess episode on building great firms.

Amit largely agrees but flags two areas of caution. On government funding of higher education and R&D, he says he broadly agrees with private-competition-driven innovation as the primary engine, but flags that "how much" the government should invest remains an open philosophical question not being fully litigated here. On breaking up monopolies, Amit's view is that nearly all lasting monopolies arise through state collusion, and that in a genuinely competitive market, monopoly power tends to dissolve on its own given time, so he would be wary of government overreaching into active social engineering even in the name of promoting competition.

The chapter, and the episode's substantive argument, closes with the story of SEEPZ (Santa Cruz Electronics Export Processing Zone), built in the 1970s by bureaucrats trying to replicate East Asia's electronics export success by removing customs duties within a bonded zone. The zone never became a major radio manufacturing hub as intended. Instead, entrepreneurs used the same import-export freedoms to build two entirely different industries: diamond polishing, where India today polishes an estimated 55% of the world's diamonds, and early computer software, by importing hardware and hiring Indian programmers to build software for export.

"What do we learn out of this? That you can't predict, you can't control, but adding freedom is always a good thing. Increasing freedom is always a good thing. The firms will surprise us in what they will do with the freedom."

Supplementary Resources

• Economic Calculation in the Socialist Commonwealth by Ludwig von Mises (Book chapter)
• The Use of Knowledge in Society by F. A. Hayek (Journal article)
• India: Planning for Industrialization: Industrialization and Trade Policies Since 1951 by Jagdish N. Bhagwati and Padma Desai (Book)
• The Political Economy of the Rent-Seeking Society by Anne O. Krueger (Journal article)
• Industrial Policy in an Era of Globalization: Lessons from Asia by Marcus Noland and Howard Pack (Book)
• Is There a Case for Industrial Policy? A Critical Survey by H. Pack (Journal article)
• Industrial Policy for Development: Approaches in the 21st Century (Book)
• The Changing Nature of International Trade and its Implications for Development by Pinelopi Goldberg and Michele Ruta (Working paper)
• The Return of Industrial Policy by Douglas Irwin (Resource)
• Designing Industrial Policy for Development by Vishnu Venugopalan (Resource)
• The World Bank Group and Industrial Strategy by Charles Kenny (Resource)
• What Is Industrial Policy? What Is It for? by Pierre Lemieux (Resource)
• Ajay Shah On 4 Pillars Of Industrial Policy, And Why They're All Bad by Ajay Shah and Rahul Ahluwalia (Resource)

The complete transcript file is available to download below.