Doubts about industrial policy – Conversable Economist

“Industrial policy” can be distinguished from “business-friendly policy” by the degree of involvement in targeting. Industrial policy selects industries that will favor the combination of subsidies, tax breaks, and trade protectionism, and sometimes even companies that will. Common examples in the recent US context include attempts to prioritize automobiles, steel, semiconductors, electric vehicles, and solar panels. On the other hand, a business-friendly environment aims to create a set of educational, infrastructure, tax, research, regulatory, and other opportunities that give many different types of businesses a chance to compete, innovate, and thrive, but avoid choosing either industries or firms.

The world economy appears to be entering an era of industrial policy, and Finance and Development (published by the IMF) recently offered a couple of readable essays on the subject. Ruchir Agawal wrote “Industrial Policy and the Growth Strategy Trilemma” (published online March 21, 2023). Douglas Irvine added:The return of industrial policy. (expected in June 2023 release)

It may be helpful to state what should be an obvious fact about industrial policy: there can be no easy way for governments to achieve economic prosperity. Otherwise, each country could simply choose the industries in which it wants to succeed and then use industrial policy to achieve prosperity. Thus, it is not surprising that it is easy to make a list of industrial policies that have gone awry.

For example, back in 1991, Linda Cohen and Roger Knoll published a book called TTechnological barrel with pork, which was based on case studies of US attempts to create a nascent industry in supersonic aircraft, communications satellites, space shuttles, breeder reactors, photovoltaic cells, and synthetic fuels. I remember Japan in the 1980s announcing the Fifth Generation computer project with great fanfare, which then went off without fanfare. I remember when Japan was a prime example of how industrial policy worked in the 1970s and 1980s, but somehow it abruptly ceased to be a prime example as the Japanese economy entered three decades of stagnation that began in Brazil. producing electricity in the 1970s and 1980s, and when Argentina decided it would become the world’s electronics superpower. I remember the economic disaster that was the industrial policy of the Soviet Union. I remember places all over the world trying unsuccessfully to be the next “Silicon XXXX”.

Was the US economy in the 19th century an example of a successful industrial policy? Irwin says “no”:

The belief that wealthier countries succeeded because they protected manufacturing gave respectability to industrial policy. This turned out to be a misreading of history. Despite high tariffs, the United States developed as an open economy—open to immigration, capital, and technology—and a country with an exceptionally large domestic market that was fiercely competitive. Moreover, the high-tariff United States overtook free-trading Britain in per capita income in the late 19th century by increasing productivity in the service sector, not by increasing productivity in the manufacturing sector.Broadberry 1998). In Western Europe, growth has been driven by the transfer of resources from agriculture to industry and services. Trade policies designed to protect agriculture from low prices have likely slowed this transition in countries like Germany.

Was Korea’s economic success the result of industrial policy? Irwin says “no” again:

The experience of the successful countries of East Asia has given it a positive connotation, but even here the standard story can be misleading. In 1960, South Korea was saddled with an overvalued currency and exports of just 1 percent of GDP. The country’s ability to import is almost entirely dependent on US aid. After the devaluation of its currency in the early and mid-1960s, Korea’s exports became more competitive and grew rapidly, reaching 20 percent of GDP by the early 1970s. The main policy was to set a realistic exchange rate that allowed exports to flourish along with cheaper credit for all exporters rather than targeted industries (Irvine 2021). Industrial policy did not really start until the “Heavy and Chemical Industries Movement” of 1973–1979, which was later abandoned due to its excessive costs and inefficiency. But Korea’s rapid growth began before the era of industrial policy.

What about China’s efforts to build a domestic aviation industry? Agarwal writes:

However, China’s recent experience with the COMAC C919 shows that industrial policy is far from a magic wand. Driven by the belief that a great nation should have its own airliners, China has invested heavily in the development of its commercial aircraft to challenge the dominance of Boeing and Airbus. Although up to $70 billion was invested in China State Aircraft Corporation (COMAC), the project was delayed by more than five years due to regulatory, technological and supply chain obstacles. The delays were exacerbated by special licensing requirements for the export of technology parts to China, introduced by the Trump administration in 2020. The C919 has also not yet been certified by any major aviation authority outside of China, due in part to safety concerns. Thus, despite the success of industrial policy with its domestic high-speed rail network in the 2010s, China has not been able to replicate this achievement in the competitive global aviation industry.

Or China’s efforts to create a domestic shipbuilding industry? Irvine writes:

China shows how industrial subsidies can be an inefficient way to spend scarce resources. In 2006, China defined shipbuilding as a “strategic industry” and began massive subsidies for production and investment, mostly through cheap loans. The available evidence suggests that these policies did not provide much benefit, but were wasteful (due to excess capacity) and distorted markets (forcing more efficient countries to adjust by reducing output). China’s share of the global market has been growing driven by low-cost manufacturers in Japan, South Korea, and Europe, but has not generated significant profits for domestic producers (Barwick, Panle Gia, Mirto Kaluptsidi and Nahim bin Zahoor. 2019). Subsidies were squandered by the entry and expansion of less efficient producers, creating excess capacity and increasing industry fragmentation. The loans were political in the sense that state-owned enterprises rather than the more efficient private producers received the bulk of the support. The shipbuilding industry did not significantly impact the rest of the economy, and there was no evidence that industry practice was learning from experience. … China got rich not by industrial policy, but by increasing agricultural productivity, allowing foreign investment in manufacturing, and freeing up the private sector.

The problems of industrial policy are well known. If an idea seems profitable, entrepreneurs and established companies will invest their own money to make it a reality. Thus, industrial policy comes into play only when politicians, who do not invest their own money, decide that some idea that they think is not sufficiently supported by the private sector will nevertheless certainly make money. and create jobs. Of course, sometimes a blind squirrel finds an acorn. But choosing among the remaining ideas that private capital does not consider worthy of financing is, on average, unlikely to be a winning idea. Of course, at least some private firms and funding sources will respond to government subsidies and accept cash. In doing so, such firms will focus on how to attract political favoritism, which is not the same as deciding how best to produce high-quality products at lower cost. And a clear preference for some industries, technologies, or firms will be implicitly unfavorable for others.

However, here we are again. Agarwal notes recent efforts to develop US industrial policy on semiconductors and clean energy that follow the Trump administration’s industrial policy efforts in favor of steel and aluminum. Agarwal continues:

Japan, meanwhile, is providing more than $500 million in subsidies to 57 companies to encourage them to invest domestically as part of their efforts to reduce dependence on China. Similarly, the European Union is expanding its industrial policy, including allocating 160 billion euros from its COVID-19 recovery fund to digital innovations such as chips, batteries and climate change adaptation. In response to massive subsidies under the US Inflation Reduction Act, Italy’s economy minister recently called for a unified EU approach to support competitiveness and protect strategic production.

The real problem with industrial policy is to be sober and selective: that is, not to choose industries in which it would be nice to be a world leader, but to choose those in which the conditions of time, place and technology come together. a path along which a certain country at a certain time is ready to take the next step.

Take solar panels as an example: in particular, China’s leading role in the global economy as a manufacturer of low-cost solar panels. Yes, China supports its solar industry. But the US favored photovoltaics back in the 1970s and 1980s. Japan went through a phase of favoring solar panels in the 1980s and 1990s, and so did Germany in the 21st century. In other words, the success of China’s industrial policy as a supplier of solar panels was based on decades of research and investment in other major economies that did not pay off in terms of costs for those other countries at the time, combined with China’s skills in low-wage and inexpensive production. Conversely, China’s failed industrial policy in shipbuilding, aircraft, semiconductors, and other industries is an example of China choosing industries where it would be nice to be a leader, but ignoring signs that, given existing technology and the realities of the Chinese economy, China unable to be a leader in these areas.

Here I will give Agarwal the last word:

Former US Treasury Secretary Lawrence Summers recently said he loves his industrial policy advisers as much as he loves his generals. “The best generals are those who hate war the most but are ready to fight when needed. What worries me is that industrial policy people love to do industrial policy.” In this context, the Trilemma reminds policy makers of a cautious approach to industrial policy, while emphasizing long-term growth, stability and international cooperation. … Just like salt in cooking, a pinch of industrial policy can be helpful, but too much can overwhelm, and prolonged excess can hurt.

For those who want more, here are some posts about industrial policy from the last few years: