Government as Landscape Designer: A Behavioral View of Industrial Policy

The strategic management literature has built rich and behaviorally plausible models of firms, yet the industrial policy literature has overlooked nuances in firm behavior. This paper bridges these two literatures by incorporating increased micro-level realism to examine how industrial policy affects firms. More specifically, we develop a formal model to study how commonly held results on the effects of two prominent types of industrial policy—regulations and incentives—change when we account for the behavioral aspects considered in strategic management. We specify conditions under which, contra results in the industrial policy literature: (i) policy instability can be beneficial (through what we term the “training” and “dislodging” effects) and (ii) firm performance can benefit from the industrial policy of a government with limited ability for identifying and enacting optimal policies. We also show how environmental complexity, an understudied factor in that literature, is a strong moderator of the effect of industrial policy. Managers can use these results to devise better means of coping with and leveraging the effects of industrial policy. Our findings also have implications for organizational search and R&D governance.