The Return of Industrial Policy
Dani Rodrik
CAMBRIDGE – British Prime Minister Gordon Brown promotes it as a vehicle for creating high-skill jobs. French President Nicolas Sarkozy talks about using it to keep industrial jobs in France. The World Bank’s chief economist, Justin Lin, openly supports it to speed up structural change in developing nations. McKinsey is advising governments on how to do it right.
Industrial policy is back.
In fact, industrial policy never went out of fashion. Economists enamored of the neo-liberal Washington Consensus may have written it off, but successful economies have always relied on government policies that promote growth by accelerating structural transformation.
China is a case in point. Its phenomenal manufacturing prowess rests in large part on public assistance to new industries. State-owned enterprises have acted as incubators for technical skills and managerial talent. Local-content requirements have spawned productive supplier industries in automotive and electronics products. Generous export incentives have helped firms break into competitive global markets.
Chile, which is often portrayed as a free-market paradise, is another example. The government has played a crucial role in developing every significant new export that the country produces. Chilean grapes broke into world markets thanks to publicly financed R&D. Forest products were heavily subsidized by none other than General Augusto Pinochet. And the highly successful salmon industry is the creation of Fundación Chile, a quasi-public venture fund.
But when it comes to industrial policy, it is the United States that takes the cake. This is ironic, because the term “industrial policy” is anathema in American political discourse. It is used almost exclusively to browbeat political opponents with accusations of Stalinist economic designs.
Yet the US owes much of its innovative prowess to government support. As Harvard Business School professor Josh Lerner explains in his book Boulevard of Broken Dreams, US Department of Defense contracts played a crucial role in accelerating the early growth of Silicon Valley. The Internet, possibly the most significant innovation of our time, grew out of a Defense Department project initiated in 1969.
Nor is America’s embrace of industrial policy a matter of historical interest only. Today the US federal government is the world’s biggest venture capitalist by far. According to The Wall Street Journal, the US Department of Energy (DOE) alone is planning to spend more than $40 billion in loans and grants to encourage private firms to develop green technologies, such as electric cars, new batteries, wind turbines, and solar panels. During the first three quarters on 2009, private venture capital firms invested less than $3 billion combined in this sector. The DOE invested $13 billion.
The shift toward embracing industrial policy is therefore a welcome acknowledgement of what sensible analysts of economic growth have always known: developing new industries often requires a nudge from government. The nudge can take the form of subsidies, loans, infrastructure, and other kinds of support. But scratch the surface of any new successful industry anywhere, and more likely than not you will find government assistance lurking beneath.
The real question about industrial policy is not whether it should be practiced, but how. Here are three important principles to keep in mind.
First, industrial policy is a state of mind rather than a list of specific policies. Its successful practitioners understand that it is more important to create a climate of collaboration between government and the private sector than to provide financial incentives. Through deliberation councils, supplier development forums, investment advisory councils, sectoral round-tables, or private-public venture funds, collaboration aims to elicit information about investment opportunities and bottlenecks. This requires a government that is “embedded” in the private sector, but not in bed with it.
Second, industrial policy needs to rely on both carrots and sticks. Given its risks and the gap between its social and private benefits, innovation requires rents – returns above what competitive markets provide. That is why all countries have a patent system. But open-ended incentives have their own costs: they can raise consumer prices and bottle up resources in unproductive activities. That is why patents expire. The same principle needs to apply to all government efforts to spawn new industries. Government incentives need to be temporary and based on performance.
Third, industrial policy’s practitioners need to bear in mind that it aims to serve society at large, not the bureaucrats who administer it or the businesses that receive the incentives. To guard against abuse and capture, industrial policy needs be carried out in a transparent and accountable manner, and its processes must be open to new entrants as well as incumbents.
The standard rap against industrial policy is that governments cannot pick winners. Of course they can’t, but that is largely irrelevant. What determines success in industrial policy is not the ability to pick winners, but the capacity to let the losers go – a much less demanding requirement. Uncertainty ensures that even optimal policies will lead to mistakes. The trick is for governments to recognize those mistakes and withdraw support before they become too costly.
Thomas Watson, the founder of IBM, once said, “If you want to succeed, raise your error rate.” A government that makes no mistakes when promoting industry is one that makes the bigger mistake of not trying hard enough.
Dani Rodrik, Professor of Political Economy at Harvard University’s John F. Kennedy School of Government, is the first recipient of the Social Science Research Council’s Albert O. Hirschman Prize. His latest book is One Economics, Many Recipes: Globalization, Institutions, and Economic Growth.
Copyright: Project Syndicate, 2010.
www.project-syndicate.org
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wauch 01:48 14 Apr 10
I wonder does "...the capacity to let the losers go..." apply to the folks at Blackwater, KBR, Airbus, General Dynamics. Sure they have produced people and tools that protect, kill, or transport war-time tools, but have we not been handed a bill far in excess of what the product(s) cost. Eisenhower noted the Military Industrial Complex and we are seeing this philosophy creep into agriculture and I would argue pharmaceuticals. The fact that Friedmanites demonise industrial policy when applied to healthcare and related social safety networks not to mention energy is really hypocrisy of the highest order. Vox Populi!!!
mgheller 04:18 14 Apr 10
This is faith-based economics. There is a religious quality about Rodrik's stubborn belief in government’s divine capacity to shape efficient economic designs. Since his writing is very influential as well as wrong-headed, it needs refutation.
First, he calls for various forms of organized government-business collaboration. In the advanced societies this was called corporatism. Despite having the advantage of modern state institutional capacity Germany and the UK largely gave up corporatism when it became obvious that corporatism was inflexible and non-evolutionary. In developing countries without formal divisions of powers and democratic accountability, government-business 'embeddedness' is more likely to simply take the form of collusion and rent seeking. Rather than engineering “financial incentives” or utopian “states of mind”, governments can more usefully focus on the economic incentives that nature provides by improving regulatory framework to ensure formally equal playing fields for competitive markets in which the incentive for cost discovery is the possibility of extinction.
Second, Rodrik calls for temporary and performance-based government incentives. This is pie in the sky. No political system has ever been devised that could withstand the interest-group pressures implied by any state-activist form of promoting business. It may reasonably be said in line with Schumpeterian theory that government’s job is to ensure that monopolistic privileges generated by market actors can only ever be temporary. It is not, however, government’s role to generate those privileges in the shape of subsidies or protection given in return for state-defined performance targets.
Third, Rodrik calls for transparent and accountable decision making in industrial policy, leaving the field open to new entrants. The welfare states in advanced democracies are already overloaded. It is absurd to suggest that governments should actually expand their field of microlevel discretionary decision making about individual enterprises. Authoritarian industrial policy is bad enough. ‘Democratic’ industrial policy subject to public choice lobbying dynamics would be worse!
Fourth, Rodrik claims there is a difference between picking winners and identifying losers. The distinction is spurious. It would not be necessary to identify a loser (and withdraw a public subsidy) unless there had already been a wasteful effort to pick a winner. Whilst it is true that learning is by doing, i.e. by trial and error, the prior task of policymaking can reasonably be to predict the unintended consequences of stupid policies. There is no point in making errors deliberately for the sake of learning. The onus of cost discovery should lie with business (when it fails) rather than the government that foots the bill. In any case, monitoring of business errors by government requires an unlikely army of politically detached and superbly disciplined bureaucrats. Even if bureaucrats had enough expert knowledge of economic life to pick winners and identify losers (which they don’t) it would still be a costly, risky and unnecessary task for government to undertake.
Fifth, there is of course evidence that industrial policy can succeed, for a while. But there are just as many examples of its catastrophic failure. If we leave aside island or city states such as Singapore, there is not a single country in the world in which the types of large-scale and prolonged neoactivism Rodrik proposes in his most recent book have not eventually led to political decay and economic crisis. Just look at Japan. (China cannot possibly sustain its present path.)
I describe the Weberian counter-logic to Rodrik’s neoactivism more fully in chapter six of my book Capitalism, Institutions, and Economic Development (2009).
Michael G. Heller
phermarquez 06:35 14 Apr 10
As our fellow said below, I'm not that sure on how regulation can promote industry. I see the DOE measures with kind eyes. Regulation is always very polemic through the private sector to work as the leading force of development. Though it's necessary, the best way to incentivate it is injecting some dollars in it.
Mountern 02:24 20 Apr 10
What is industrial policy but another word for infant industry policy. If only economist stop venturing into the branding business they would have better predictive skills.
The problem with admitting USA also has an infant industry policy is the economist can't take the heat from expected criticisms from fellow economists in USA. If you ever wonder why this world is full of confused economists this is it. Economists are beholden to the masters that pay them and their point of view must necessarily toe the line of the masters'.
cheeheongquah 09:45 08 May 10
If you compared the successes brought about by government polices and those by the private market, which side would have more?
Undoubtedly, the private side would have more and it worked more efficiently than government did.
Hence, it can be concluded that industrial polciies may be good but not necessary and might even result in unnecessary wastage and deadweight loss.
Quah, Chee Heong
persona 02:51 12 Apr 10
Ultimately industrial policy means favor one industry instead of others. This reminds me of the arguments for protectionism and counter arguments against it rings well in this debate. Best way to promote one industry is tariffs, quotas all sorts of protectionist measures but these are mostly out of scope of WTO agreements covering nearly all international trade of industrial goods. and real question is who will decide which industry should be favored by government. old fashioned international trade policy says the answer is market. Except in two case infant industries and strategic trade policies all protectionist policies is worse than market solution if one industry is deem to be worth protection market forces already do the job
Government must change incentive schemes along the industries. Spending $40 billion in loans and grants by US Department of Energy is bad governance in terms of industry government relations. DOE has better and cheap tools to promote green technology called regulation The so called nudge should be the kind of regulation