The burden of proof to demonstrate why a government should pursue an industrial policy is on industrial-policy advocates.
Industrial-policy advocates should explain how they might overcome these six barriers to economic planning.
Editor’s note: The following is adapted from chapter three of The Next American Economy: Nation, State, and Markets in an Uncertain World by Samuel Gregg, with permission from Encounter Books.
T hrough the 1980s and early 1990s, you didn’t have to look far to find Americans convinced that America’s place in the global economy was threatened by Japan. The tone of these publications often verged on the apocalyptic.
In Trading Places: How We Are Giving Our Future to Japan and How to Reclaim It, Clyde V. Prestowitz maintained that if America did not embrace Japanese ways, it might become an economic colony of Tokyo. Likewise, American legislators and CEOs complained of the ubiquity of Japanese cars, computers, and technology, fretted about whether America could compete, and called for higher tariffs against Japanese imports. Above all, they insisted that what’s commonly known as industrial policy had to be the centerpiece of the 21st-century American economy.
A quarter of a century later, similar arguments emerged with force across America with reference to another East Asian power. If government didn’t take a far more proactive role in shaping the American economy’s composition in ways that went far beyond what advocates of limited government would typically accept, America was destined to be left in the dust by Communist China. Alongside this went another argument: that extensive use of industrial policy was necessary if particular regions and demographic groups in America were to have meaningful futures.
Industrial policy is hardly foreign to the American economic experience. Those who want America to make extensive use of industrial policy are not thus asking for a fundamental change in direction. They are asking for more of something that already exists.
The fact, however, that industrial policy is part of America’s economic landscape also means that we can examine its track record and judge whether it should play a larger role in the U.S. economy.
Industrial policy involves trying to alter the allocation of resources and incentives in particular economic sectors that would otherwise transpire if entrepreneurs and businesses were left to themselves. The goal is to produce better results in that economic sector. Efficiently realizing such goals assumes, however, that political leaders, civil servants, and technocrats possess the knowledge to comprehend all the technical details, possible methods of production, the range of incentives, actual and future prices, unintended consequences, and alternative uses of resources (to name just a few sets of information) that they would need to decide accurately the most optimal allocation of resources and course of action.
Alas, no one can know all these things about a given economic sector, let alone an entire economy. Even those attempting to implement industrial policy on a relatively small scale have to confront the fact that all the information they would need to achieve their goal efficiently is dispersed among thousands of people and is constantly changing. Some of the information that they require does not even exist yet.
In sum, humans lack not only all the data but also the ability to assimilate all the information they would need to be able to say with a considerable degree of confidence that a given industrial policy will realize a particular outcome efficiently or even effectively. Industrial-policy advocates often respond by saying that this over-theorizes the problem. Of course, they argue, humans can’t know everything. No entrepreneur or business, they point out, can know everything about their present and future market. And yet we allow them to embark upon thousands of endeavors, many of which fail — sometimes spectacularly. Why, it follows, should we not let technocrats and government officials engage in similar activity?
A second argument of some industrial-policy supporters is that while they recognize that realizing the goal is likely to be an inefficient and costly process, there are times when efficiency needs to be sacrificed if important economic and non-economic goals are to be achieved.
Third, even if industrial policy fails, some industrial-policy boosters maintain that there is a significant possibility that it will have positive spillover effects. While these are unplanned, they end up indirectly benefiting many businesses and consumers.
There are no fewer than six major problems which, I’d suggest, should cause us to be skeptical about these claims.
The first is called opportunity costs. If the state chooses to subsidize a particular company or inject capital into a particular economic sector, it cancels out the opportunity for those resources to be invested elsewhere. No government department — let alone a single technocrat — can know if the forgone alternatives might have been more profitable. No legislator or expert can consequently claim with any meaningful degree of certainty that a particular industrial policy will produce more benefits that would have resulted if the state had not implemented the policy.
The second problem is that there is a major difference between private-sector initiatives and enterprises driven by industrial policy. Those involved in a private endeavor directly bear the costs of failure in economic and reputational terms.
The same cannot be said of the government department or technocrat responsible for the design and implementation of a failed industrial policy. For one thing, their personal resources are not at stake: those costs are borne by and dispersed among millions of taxpayers. Such individuals are also usually insulated to varying degrees from other costs of failure. Career government officials are notoriously hard to fire. They might find themselves transferred to another project or department. Rarely, however, are they let go.
Third, industrial policies are strongly political in their character and ends. They are created and overseen for the most part by elected officials, political appointees, and government employees. And because they are created through political processes, industrial policies are especially open to capture by rent-seeking individuals and groups who are forever looking for subsidies and skilled at explaining why they are uniquely equipped to implement the policy. That dramatically lowers the likelihood of industrial policy being characterized by a concern for economic efficiency while simultaneously raising the odds that the real goal will become the enrichment and perpetual privileging of those implementing the policy at everyone else’s expense.
Fourth, government use of industrial policy undermines the market’s ability to furnish the accurate information needed by entrepreneurs, investors, and businesses to identify the most optimal economic path for each of them to follow — a process which constantly allows millions of piecemeal improvements to be made across the overall economy. By contrast, if industrial policies become a central feature of economic life, inefficiencies will grow throughout the economy as people act on the basis of increasingly bad information.
Fifth, industrial policy supposes that if markets apparently fail to produce certain products, or to foster certain economic sectors deemed important for regional or national well-being, the government must intervene to rectify the problem. But what if the failure is not one of the private sector at all? What if the problem is primarily government failure? Even relatively free economies contain numerous distortions that flow from government interventions that create perverse incentives for labor and capital to flow in less-than-optimal directions. The solution to such problems is less government intervention, not an industrial policy.
Sixth, industrial policy has difficulty proving its effectiveness in achieving both general and specific goals. Industrial policy is often touted as necessary to initiate or accelerate growth in a region or even a country. But it is hard, for instance, to establish causality between a given industrial policy and economic growth.
East Asian countries such as Malaysia, South Korea, Taiwan, Thailand, and Japan are regularly posited as late-20th-century examples of industrial policy being successfully used to transform these nations economically. Yet as a 1993 World Bank analysis of the East Asian economic miracle stated: “It is very difficult to establish statistical links between growth and a specific intervention and even more difficult to establish causality. Because we cannot know what would have happened in the absence of a specific [industrial] policy, it is very difficult to test whether interventions increased growth rates.”
At a minimum, these six issues with industrial policy should make its advocates circumspect, and more humble, before they claim that particular interventions might facilitate greater overall growth, ignite a new economic sector, or produce thousands of manufacturing jobs in Western Pennsylvania. Nor can they rule out the possibility that a given industrial policy may undermine the economic and political well-being of a country, region, or industry, whether by generating massive inefficiencies that compromise the adaptability of part or all of the economy, or by creating tremendous incentives for businesses and politicians to engage in the cronyism which does such damage to the integrity of the political system. If all this is true, the burden of proof is on industrial-policy advocates to demonstrate why a government should pursue an industrial policy.