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Can Subsidies Discipline Capital?


Jeff Gordon (@jeffgordon12) is an Associate Research Scholar and Fellow in Private Law at Yale Law School.

Industrial policy exemplifies a middle ground between capitalism and socialism: private firms pursue their own ends as they see fit, but they do so subject to guidance and guardrails set out by a developmental state. The basic challenge of this arrangement is: how can we ensure that firms accept the obligations, and not just privileges, of public support? Or, as Ha-Joon Chang puts it, “the success of industrial policy depends critically on how willing and able the government is to discipline the recipients of the rents that it creates.”

In examining this challenge, some commentators have proposed a dichotomy between “derisking” and “discipline.” To oversimplify the discourse slightly, derisking is associated with subsidies or guarantees to firms—thus making private investment less risky—while discipline is associated with coercive mandates. As Daniela Gabor articulates the difference, “derisking and capital discipline are fundamentally at odds because the former relies on private profitability to enlist private capital while the latter forces capital into pursuing the strategic objectives of the state even where these may be at odds with…profit calculations.”

From this perspective, the Biden administration’s recent foray into industrial policy can look disappointing. The Inflation Reduction Act (IRA) and CHIPS Act both rely on voluntary inducements to push firms to invest in renewable energy technology and domestic manufacturing. Observers like Gabor worry that the result will be paltry: firms will pursue the same priorities they would have absent the legislation, just with a better financial return. What we really need, according to this perspective, are more muscular directives that force capital to abandon dirty industries. Yet, as I will argue in the following post, derisking and discipline are not so neatly opposed. Discipline can come in many forms, some of which are indifferent to private profitability, but others of which mold the landscape of profitability into a disciplinary force itself. Recognizing this should be empowering: state planning can extend into areas where law, politics, or prudence forbid command-and-control regulation.

The Old Discipline: Bans and Mandates

The most familiar disciplinary approach within U.S. law is negative discipline: forbidding certain behaviors or discouraging them through Pigouvian taxation. The EPA takes this approach when it bans chemicals like PCBs under the Toxic Substances Control Act. Most economists’ favored response to climate change, carbon taxation, would enforce negative discipline on carbon emitters.

Negative discipline is an essential tool, but it often leaves a gap between the legacy behavior it discourages and the new alternative we might hope to see take its place. In the energy context, for example, making fossil energy marginally more expensive through a carbon tax would not necessarily help anyone afford the massive fixed investments needed to replace old infrastructure with new renewable assets. Transitioning from a bad status quo to a better future will often require government to play a coordinating role, helping private actors forge a consensus about the new way of doing things rather than merely stating what not to do.

This naturally leads us to the inverse of a ban: a positive command, mandating what firms must do. In the United States, mandates to engage in a particular form of commerce are difficult to sustain under the Supreme Court’s reasoning in NFIB v. Sebelius, which rejected the Commerce Clause basis for the individual mandate. However, the same decision upheld Congress’s power to tax the failure to engage in certain commerce, and, at least for now, threatening taxes for failure to participate in prescribed activity remains a powerful disciplinary tool. For instance, under the  Medicare drug price negotiation program (authorized by the IRA), if pharmaceutical companies decline to participate in price negotiations, the IRS is directed to impose up to a 1900% excise tax on the relevant drugs. The Congressional Budget Office estimates no revenue from the provision because drug-makers are expected to comply: perfect discipline. Predictably, litigation is ongoing as to whether the threatened tax is excessively coercive.

Legal risk aside, tax-backed mandates make more sense when policymakers want the mandate to apply to every firm in a given category, but less sense when policymakers do not know in advance which firms will be able to comply. Scholars refer to this as a “specification problem.” For example, a mandate to build small modular nuclear reactors would penalize every company in America besides possibly one, NuScale, the only company yet to achieve regulatory approval for such a project. In the face of specification problems (not to mention political and legal hostility to mandates), it makes more sense to let firms opt in to a bargain with the government rather than mandating performance.

The New Discipline: Contracts and Competition

In a forthcoming article, I describe certain such bargains as “statutory contracts”: Congress offers to pay if and only if a private counterparty steps forward and performs the activities named in the statute. Once the counterparty completes substantial performance, the government is bound by the contract, and once the government pays, the counterparty is also bound (e.g., prohibited from ceasing performance for some amount of time). Statutory contracts—which are used throughout the IRA—enforce discipline in the manner of contracts generally, i.e. by imposing benefits and burdens on those who opt in. Payment is only available upon delivering some outcome—a batch of wind turbine blades, a domestically assembled electric vehicle battery, a new geothermal plant. And penalties can be assessed if the recipient’s subsequent behavior undermines the activity for which they were paid. In the case of the investment tax credit, recipients will be forced to return part of their payout if they cease operating the facility that earned the credit within five years.

The point is not that the IRA included all of the right conditions—for example, its subsidies could have set minimum wage levels for workers who will staff IRA-funded factories, not just for those who help construct them. The point is simply that the statutory contract mechanism can accommodate a range of public-minded conditions in exchange for derisking private investment.

But what about the firms that don’t opt in to such offers? For those who find the IRA lacking in discipline, a leading reason is that it relies on voluntary inducements. Might we expect that the firms whose conduct is most in need of changing would be least likely to opt in to conditional subsidies? That perspective might make sense if each firm operated in an individualized vacuum, but falls apart in light of competitive dynamics. The key insight is that conditional subsidies do not only alleviate risk; they also impose a new risk of falling behind competitors who willingly comply with the conditions. By creating a new, highly reliable route to profitability, the state grants a competitive advantage to the subset of firms most inclined to opt in.

The threat of falling behind rivals is profoundly disciplinary—just discipline mediated through competition rather than imposed directly through regulation. We see this dynamic at play in the green hydrogen industry. One leading producer of hydrogen fuel cells, Plug Power, has warned that its investment plans will only be viable if the IRA’s hydrogen production tax credit is conditioned on relatively permissive energy efficiency rules. But Air Products, a rival hydrogen producer, is happy to comply with more exacting standards—which is fortunately closer to the direction indicated by the IRS’s proposed rules. Scholars often decry regulations that impose differential burdens as evidence of regulatory capture. But when one company is better aligned with public policy than its rivals are, we should embrace tilting the competitive landscape in its favor, whether through carrots, sticks, or both. The laggards will either change their behavior or be replaced by new entrants better suited to the new rules of the game.  

The obvious constraint on granting competitive advantages as a tool of indirect discipline is that many markets are not actually competitive. The same patterns of concentration that give dominant firms market power over customers, workers, and suppliers also generate a form of market power against the state: the power to refuse otherwise tempting offers. The inverse is also true: when the government has market power as a monopsonistic buyer (e.g., in its military procurement), it can impose nearly any condition. Aware of all this, firms try to monopolize the markets that receive subsidies or procurement contracts so that they can benefit from public spending without facing competitive pressure to deliver quality outcomes. We see this in the heat pump industry, where private equity firms are rolling up local installers so as to seize IRA subsidies without passing the benefits on to consumers, and in the government software industry, where leading contractors acquire startup competitors to entrench their hold on procurement contracts.

It also follows that granting competitive advantages cannot serve as a tool of discipline on firms with state-granted monopolies, i.e. regulated utilities. In fact, the entire appeal of derisking is toothless as applied to utilities, which definitionally face no market risk: in the typical U.S. utility model, they are granted a fixed rate of return on equity. This dynamic accounts for an emerging weak point of the IRA: regulated electric utilities have been unmoved by the prospect of subsidies, which they would have to share with their ratepayers to the extent the subsidies would exceed the fixed rate of return. By contrast, and unsurprisingly per the theory presented above, electric generators in competitive markets have been quick to make claims on the same subsidies. The upshot is not necessarily to prefer deregulated energy markets on this basis, but instead to realize that trying to de-risk utilities is a square peg in a round hole, and that more tailored interventions in state-level utility governance is the only way to motivate that subset of firms.


The general principle to draw from these examples is that the most effective form of discipline depends on what motivates a given firm. Regulatory mandates and associated taxes or penalties motivate every firm, and so they should be the first arrow in the disciplinary quiver when politically and legally viable. But when they are not, policymakers sensibly turn to the struggle for profit as a potential source of leverage. Firms make their own profits, but they do not make them under self-selected circumstances. Selective de-risking is just another name for choosing which activities to make more and less profitable, and which competitors to make more and less threatening. Under capitalism, the playing field is never level. Industrial policy is the act of tilting it toward public ends.