Background

Industrial policy has emerged as a hotly debated topic in development economics and on the policy front worldwide (Juhász et al. 2024). From South Korea’s semiconductor strategy to Germany’s Industry 4.0, governments increasingly intervene in markets to promote innovation and technological upgrading. In 2015, China launched the ambitious plan known as “Made in China 2025” (MC2025), which targeted ten high-tech manufacturing sectors for strategic support. Critics argue that such policies distort markets and misallocate resources, while proponents contend that they help the country escape the middle-income trap and climb global value chains.

Recent research highlights the mixed results of industrial policies (Aghion et al. 2015, Juhász et al. 2024). While some studies document positive effects on firm innovation and productivity (Howell 2017, Lane 2025), others point to inefficiencies and crowding-out effects (Boeing 2016). What’s missing from this debate is a deeper understanding of how industrial policies interact with fundamental economic forces—particularly the role of comparative advantage.

In our recent paper (Hua et al. 2025), we contribute to this debate through the lens of a novel perspective: the congruence between firm’s factor input structures and local endowment structures. Using comprehensive data from China’s National Equities Exchange and Quotations (NEEQ)—China’s NASDAQ counterpart—we examine how congruence is associated with firm innovation and how industrial policy can moderate this relationship.

Structural congruence and firm innovation

The concept of congruence builds on the fundamental economic principle of comparative advantage (Ju et al. 2015). When the factor input structure of a firm (or an industry) aligns with the local factor endowment structure (in terms of capital-labor ratios), production becomes more cost-effective. A capital-intensive firm operating in a capital-abundant region, for instance, can access relatively cheap capital and produce more efficiently than the same firm operating in a labor-abundant region.

This insight has profound implications for innovation. Firms with higher congruence not only produce more efficiently, but also find innovation more profitable. When developing new products or technologies, these firms can leverage their cost advantages to create more competitive new products. The expected returns from R&D investments are higher, creating stronger incentives to innovate.

It is important to note that, unlike the commonly used revealed comparative advantage (RCA) measures in the literature, our congruence concept captures the deeper determinants of comparative advantage from a factor endowment perspective. This theoretically enriches the understanding of how comparative advantage shapes innovation performance and industrial policy effectiveness by focusing on the fundamental structural alignment between firms (or industries) and their economic environments.

Based on a sample of small- and middle-sized technological enterprises (SMTEs) on the NEEQ, our empirical analysis shows that firms with high congruence achieve significantly better innovation outcomes in terms of both quantity and quality, as captured by more patent applications as well as patent citations. They also exhibit significantly higher levels of R&D intensity.

The impact of industrial policy: Lessons from “Made in China 2025”

The MC2025 policy provides a quasi-experiment to understand how industrial policy affects the congruence-innovation association. Launched in 2015, MC2025 targets ten capital-intensive manufacturing sectors, with the goal of transforming China from a manufacturing hub into a high-tech powerhouse.

Through examining the interactive effect of MC2025 and congruence on innovation among SMTEs, we find that, while MC2025 aims to boost innovation, it actually weakens the positive relationship between congruence and innovation performance. Quantitatively, a one-standard-deviation increase in the congruence index was associated with more patent applications by about 9% in absence of the MC2025 policy, but for firms in targeted industries, this effect became statistically insignificant with a close-to-zero magnitude after 2015. This suggests that the policy creates distortions that override market-based incentives for innovation.

The mechanism behind this effect lies in how MC2025 channels resources to targeted firms. Our analysis shows that SMTEs in the targeted industries experience significant increases in bank loans and leverage ratios compared to SMTEs in other industries. In addition, we find no significant increase in direct government subsidies to SMTEs in the targeted industries following the national policy.

Interestingly, the policy’s effects are temporary. An event-study analysis shows that the attenuating impact of MC2025 on the association between congruence and firm innovation was pronounced in 2015–2016, immediately after the policy’s announcement. In these two years, compared with SMTEs in other industries, innovation among those in MC2025-targeted industries exhibited significantly weaker associations with congruence. However, such an interactive effect between the policy and congruence has become insignificant since 2017. This suggests that much of the effect operates through policy signaling and short-term resource reallocation rather than fundamental changes in innovation capabilities.

Policy implications

Our findings have important implications for policymakers in China and other developing countries in terms of industrial, technological, and innovation policies.

The findings on the congruence effect highlight the importance of complying with local comparative advantage determined by local factor endowment structures in boosting innovations. As many of the most advanced technologies are in capital-intensive sectors, and developing countries typically have relatively scarce capital and more abundant labor, catching-up development strategies aimed at promoting capital-intensive sector development can potentially lower overall economic efficiency and increase resource misallocations.

Furthermore, developing economies are typically dominated by small and medium-sized enterprises (SMEs). In absence of a well-functioning financial system, SMEs tend to suffer from financial constraints, whereby industrial policy tools can exert an effect in relaxing such constraints and fostering firm innovation. Nevertheless, our findings emphasize that it is important to take into account comparative advantages across sectors when selecting industries to be supported. Supporting industries with large deviations from local comparative advantage would lower the effectiveness of industrial policies and induce further distortions.

(Hua: University of Nottingham Ningbo, China; Wang: Peking University; Xia: Central University of Finance and Economics and Peking University; Zhang: Zhejiang University.)

References

Aghion, Philippe, Jing Cai, Mathias Dewatripont, Luosha Du, Ann Harrison, and Patrick Legros. 2015. “Industrial Policy and Competition.” American Economic Journal: Macroeconomics 7 (4): 1–32. https://doi.org/10.1257/mac.20120103.

Boeing, Philipp. 2016. “The Allocation and Effectiveness of China’s R&D Subsidies: Evidence from Listed Firms.” Research Policy 45 (9): 1774–89. https://doi.org/10.1016/j.respol.2016.05.007.

Howell, Sabrina T. 2017. “Financing Innovation: Evidence from R&D Grants.” American Economic Review 107 (4): 1136–64. https://doi.org/10.1257/aer.20150808.

Hua, Xiuping, Yong Wang, Junjie Xia, and Haochen Zhang. 2025. “Industrial Policy, Congruence, and Innovation: Evidence from ‘Chinese NASDAQ.’” Research Policy 54 (8): 105298. https://doi.org/10.1016/j.respol.2025.105298.

Ju, Jiandong, Justin Yifu Lin, and Yong Wang. 2015. “Endowment Structures, Industrial Dynamics, and Economic Growth.” Journal of Monetary Economics 76: 244–63. https://doi.org/10.1016/j.jmoneco.2015.09.006.

Juhász, Réka, Nathan Lane, and Dani Rodrik. 2024. “The New Economics of Industrial Policy.” Annual Review of Economics 16: 213–42. https://doi.org/10.1146/annurev-economics-081023-024638.

Lane, Nathan. 2025. “Manufacturing Revolutions: Industrial Policy and Industrialization in South Korea." Quarterly Journal of Economics 140 (3): 1683–1741. https://doi.org/10.1093/qje/qjaf025.

Lin, Justin Yifu. 2011. “New Structural Economics: A Framework for Rethinking Development and Policy.” World Bank Research Observer 26 (2): 193–221. https://doi.org/10.1093/wbro/lkr007.