Industrial Policy in Times of Market Power

Can standard measures of industrial policy such as R&D subsidies or financial support for machine replacement be effective tools to reverse the current pattern of increasing market power and declining business dynamism? To answer this question we explore the effects of various industrial policy instruments in a macroeconomic agent-based model calibrated to reproduce the decline in US business dynamism over the last half-century. Our results indicate that R&D subsidies alone are insufficient to address the underlying causes of declining dynamism. They become effective, however, when combined in a policy mix with knowledge diffusion policies, particularly those favoring advanced technology adoption by small firms. In this case, industrial policy fosters growth by closing the productivity gap between leaders and laggards, and thereby curbing market power. These findings suggests a two-pronged approach to the design of industrial policy, integrating firm-level subsidies with knowledge diffusion measures and therefore ensuring that innovation and competition policies advance together.