How not to do industrial policy
The stories that matter on money and politics in the race for the White House
Industrial policy is back as a powerful motivator for government intervention. This is true in many parts of the world. It appears to be truer for Xi Jinping’s China than it was under Deng Xiaoping, especially now that it wishes to replace investment in property as its engine of economic growth. But the most striking shift is in the US. Ronald Reagan declared that “The nine most terrifying words in the English language are: I’m from the government, and I’m here to help.” Today, the Biden administration is “helping” enthusiastically. Donald Trump, too, is an interventionist, the difference being that his way of helping is to raise tariffs. Given its historic role as proponent of the open world economy, this shift matters.
The evidence that industrial policy has become more pervasive as both an idea and a practice is clear. “The Return of Industrial Policy in Data”, published by the IMF last January, shows a marked increase in mentions of industrial policy in the business press over the past decade. A paper on “The New Economics of Industrial Policy”, published by the National Bureau of Economic Research and co-authored by Réka Juhász, Nathan Lane and Dani Rodrik, shows a steep increase in industrial policy interventions worldwide, from 228 in 2017 to 1,568 in 2022 — predominantly in high-income countries (probably because they have more fiscal room). This also lets the rest of the world accuse them of hypocrisy. (See charts.)
Economists recognise three valid arguments for such interventions. The first concerns “externalities”, or uncompensated benefits provided by a firm. The most obvious come from what workers and other firms learn from it. There also exist national security and other social externalities. The second argument concerns co-ordination and agglomeration failures: thus, a number of firms may be viable if they start together, but none may be viable if it starts on its own. The final argument concerns the supply of public goods, especially location-specific public goods, such as infrastructure. Note, crucially, that none of these is an argument for protection. As I noted last week, protection is a poor way of achieving such wider social goals.
Industrial policy works if it changes the structure of the economy in a beneficial direction. Unfortunately, there are well-known reasons why the attempt could fail. Lack of information is one. Capture by a range of special interests is another. Thus, governments may fail to pick winners, while losers may succeed in picking governments. The more money is on the table, the more the latter is likely to be true.
Yet, industrial policies can work. In a publication of the Peterson Institute for International Economics in 2021, Gary Hufbauer and Euijin Jung argued that “the outstanding success is Darpa”, the US technology funding agency. So, a successful innovation policy is possible. Place-based regional policies have also sometimes worked.
Yet failure is not the only risk. So is success. Industrial policies run the risk of provoking international retaliation. South Korea used protection of domestic markets as an indirect way of subsidising exports, thereby creating successful new industries. But it was a small country, under US protection. For larger countries, international repercussions must be taken into account. This is something China has learnt recently, with its race to dominate new “clean” technologies. That is motivating retaliation in both the US and EU, further worsening relations among the economic superpowers.
Today, the most striking new industrial policy is that of the Biden administration. A radical economist, James K Galbraith of the University of Texas at Austin states, in his analysis that “for the first time in decades, the United States has a plausible simulacrum of an industrial policy”. But it is not real: thus, “the American state has lost the capacity for concentrated and decisive effort at the forefront of technology and the associated science”. Joe Biden’s Inflation Reduction Act has multiple goals, from promoting place-based manufacturing to lowering emissions. That is problematic. Galbraith would like the US to become more radically interventionist, and so more like China. If the US is going to be interventionist, it must be more strategic. Can it truly be that?
So, how should we assess this shift in US policy towards industrial policies, matched, on the Trumpian right, by a desire to return to the high tariffs of the late 19th and early 20th centuries?
The answer is that there are now at least three bipartisan positions: nostalgia for manufacturing; hostility to China; and indifference to the international rules that the US itself created. This, then, is a new world, one in which the international trading order could reach a breaking point quite quickly.
The wisest way to pursue industrial policies is to target the identified problem as precisely as possible while minimising damaging side-effects on international co-operation, trade openness and domestic economic performance. This, alas, is unlikely to be how this ends, any more than it was in the 1930s. As has happened so often before, a fundamental shift in ideology towards nationalist and interventionist approaches is really hard to contain.
Already, with the death of “hyperglobalisation”, an era of convergence of average real incomes between emerging and developing countries and the high-income economies has ended, note Dev Patel, Justin Sandefur and Arvind Subramanian in Foreign Affairs. How much more will we lose if the new era of suspicion, protectionism and interventionism runs riot across the world?
At the very least, powerful policymakers need to approach the decisions they are making in as rational and careful a way as they can. Much is at stake.
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