Industrial Policy Returns from the Grave

PALO ALTO – One of the worst responses by officials to the financial crisis and deep recession has been to revive “industrial policy.” Once again, governments are using subsidies, mandates, regulation, and capital investment to pick industrial winners and losers, rather than using a broad, even-handed approach.

The new round of industrial policy is occurring in advanced economies such as the United States and the United Kingdom, which long resisted its worst excesses, France, which long promoted national “champions”, and emerging economies such as Brazil and China. For example, French President Nicholas Sarkozy plans to borrow 52 billion euros to promote what his government guesses or hopes will be “growth industries.” Even central banks, especially the US Federal Reserve, have been supporting particular firms and types of assets because of the financial crisis. 

Industrial policy is appealing to politicians who can favor key constituencies while claiming to be helping the economy as a whole. But it usually does far more harm than good. 

Perhaps the most contentious area of industrial policy is governments’ role in research and development. While governments have an obvious interest in military-related R&D, markets function well when the returns are received and the risks borne by private owners. For basic scientific research, the potential return will be broadly available to any and all, whether or not they paid for it and bore the risk of failure. Because private investors are unable to appropriate the returns, private markets invest too little in basic science.