Embed innovation in industrial policy

By Aditya Sinha

In 1957, the Soviet Union’s launch of Sputnik catalysed a significant strategic response from the US. Within months, NASA was established, federal science funding doubled, and educational curricula saw an overhaul. Ironically, in 2025, the US is witnessing a contraction in federal R&D outlays, citing fiscal prudence and administrative efficiency. This reversal in the global innovation epicentre presents a rare opportunity for emerging economies like India. As Joseph Schumpeter observed, innovation flourishes in moments of disruption. India must recognise this juncture not merely as a chance to catch up but as an inflection point to lead, provided it can embed innovation at the heart of its industrial policy.

From protectionism to purpose-driven innovation

To make this pivot, it is imperative to make a case for a state-led innovation policy. Neoclassical economics traditionally relegates innovation to the periphery, treating it as an exogenous variable. In contrast, Paul Romer’s endogenous growth theory posits that long-run growth is fundamentally driven by knowledge production and technological change, both of which exhibit increasing returns and spillovers. These properties create classical market failures; and as knowledge, once produced, is non-rivalrous and partially non-excludable, this leads to systematic underinvestment by private actors. Moreover, the returns to innovation are highly uncertain and often non-linear, making them ill-suited to traditional cost-benefit logic underpinning private capital allocation.

It is here that industrial policy must evolve from its legacy perception of being protectionist to a dynamic tool for capability discovery and technological deepening. India’s recent (unstated) industrial policy evolution, from regulatory liberalisation and foreign direct investment attraction under Make in India to targeted schemes such as production-linked incentive and the Semiconductor Mission, marks progress. Yet, these schemes often emphasise production volume over innovation intensity. They incentivise manufacturing scale without sufficiently integrating design, research, and tech co-development.

As Mariana Mazzucato argues, innovation policy must not simply de-risk private investment but shape markets around public purpose. In the Indian context, this means aligning industrial policy with national missions in sectors that inherently require public R&D leadership.

Building translational capacity

From a systems perspective, India must address structural failures in the innovation ecosystem. This includes not only market failures but network (fragmented coordination among actors), institutional (weak absorptive capacity in industry), and directional failures (lack of coherent policy signals on long-term priorities) too. One way to address them is by embedding adaptive governance structures rooted in the framework of “embedded autonomy”, as conceptualised by Peter Evans and expanded by Dani Rodrik and Charles Sabel. This framework articulates the need for states to simultaneously possess autonomy (insulation from narrow interest capture) and embeddedness (deep institutional linkages with firms, researchers, and intermediaries).

Such arrangements create collaborative discovery processes, where state capacity is not merely about issuing incentives but about iterative co-creation of industrial trajectories. Through learning-by-monitoring, feedback loops, and real-time policy calibration, the embedded autonomy framework enables governments to respond dynamically to technological uncertainty. For example, Taiwan’s Industrial Technology Research Institute and Germany’s Fraunhofer Institutes function not as static research centres but as living intermediaries, translating public R&D into industrial applications through close engagement with small and medium enterprises and global supply chains. In India, creating such translational institutions across regional clusters could help bridge the chasm between lab and line.

Ernest Liu demonstrates that in economies with complex production networks, targeting innovation support to sectors with high distortion centrality, upstream inputs that affect multiple downstream industries can generate large economy-wide productivity gains. For India, sectors like electronics hardware, precision engineering, and green chemistry offer such leverage points. Moreover, in the context of mission-oriented innovation policy, long-term public investment in foundational technologies must be backed by predictable, rule-based procurement commitments that can crowd in private R&D and manufacturing investments.