Saturday, September 4, 2004

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Does industrial policy actually work?

The crux of the debate about the costs and benefits of economic globalization centers around how to interpret the East Asian miracle. To advocates of economic liberalization (Xavier Sala-i-Martin, Martin Wolf, Surjit Bhalla, Brink Lindsey), the success of the Pacific Rim is due to the focus on export promotion, and the 1997-99 crisis the fault of crony capitalism coming home to roost. To skeptics of economic liberalization (Dani Rodrik, Joseph Stiglitz, Robert Wade), the success of the Pacific Rim is due to the selective protectionism and smart industrial policies pursued by the relevant states, and the 1997-99 crisis the fault of financial liberalization coming home to roost.

With this set-up, Marcus Noland has an Institute for International Economics working paper on whether South Korea's industrial policy was actually "effective." Here's the abstract:

This paper attempts to determine whether conditions amenable to successful selective interventions to capture cross-industry externalities are likely to be fulfilled in practice. Three criteria are proposed for good candidates for industrial promotion: that they have strong interindustry links to the rest of the economy, that they lead the rest of the economy in a causal sense, and that they be characterized by a high share of industry-specific innovations in output growth. According to these criteria, likely candidates for successful intervention are identified in the Korean data. It is found that, with one exception, none of the sectors promoted by the heavy and chemical industry (HCI) policy fulfills all three criteria.

Before everyone jumps up and down, bear the paper's closing paragraph in mind:

The calculations made in this paper are admittedly quite crude, and they should not be considered a test of the theoretical arguments in favor of selective intervention. Indeed, even accepting the argument put forward in this paper, one could quarrel with the specific statistical results for the reasons cited above. But beyond these questions of econometric technique, it is certainly correct to argue that the level of industry aggregation (imposed by data availability constraints) is far too high and that both the underlying externalities and the forms of intervention may be far more subtle than the relations modeled in this exercise. Nonetheless, this approach may provide a useful starting point for identifying potential candidates for industrial promotion.

posted by Dan on 09.04.04 at 10:37 PM


capital is like manure
spread carefully over a large area the beneficial effects are significant and positive.
Heaping all of it into one small corner of the field is counterproductive. Based on past history, the current "excessive" accumulation of capital will produce only irrational boom and bust fads.
What Bush thinks he is doing is "respecting" capital. What he is actually doing is devaluing the importance of capital.

posted by: wisedup on 09.04.04 at 10:37 PM [permalink]

... are likely to be fulfilled in practice.

Suppose that selective intervention works well when it's done right, but it's hard to do right.

Say that 20 nations try it and 3 succeed. The difference between the 3 that succeed and the 17 that don't is in the details.

Then the choice becomes, do you accept mediocre results knowing that some other countries will do much better? Or do you gamble on intervention and hope that you'll be one of the winners?

When I was a kid I had the idea of reading about self-made multimillionaires to see how they did it. Then I read that for every self-made multimillionaire there are 20 others who tried the same methods but wound up in jail instead.

Somehow, instead of trying to become a multimillionaire I studied mathematics.

posted by: J Thomas on 09.04.04 at 10:37 PM [permalink]

Governments pursuing industrial policy will tend to focus on areas which are currently fashionable. You can see this on a small scale in local attempts to attract business. I know someone who had started a small manufacturing business (totally clean--no environmental issues) and tried to get support from a local government's program to encourage startups. They weren't interested, because they wanted "high-tech" businesses, which to them meant dot-com types (this was during the height of the boom) Of course, most of these glamour businesses are now gone...

posted by: David Foster on 09.04.04 at 10:37 PM [permalink]

The discussion of "Asian tigers" is basically a smokescreen. One needs to look very carefully at Airbus (EADS) and similar industrial consortia/exclusionary agreements in Europe. For all the discussion of the problems Old Europe(tm) is having, the US doesn't seem to be able to figure out how to compete with these entities.


posted by: Cranky Observer on 09.04.04 at 10:37 PM [permalink]

I have to say that both the ideas that industrial policy never works under any circumstances and the idea that it might often work even if badly done seem equally unlikely to me.

Does anyone really think our auto industry would be better off if we removed our informal system of quotas and took no other action? On the other hand, maybe a carefully planned policy would be better than this one of imposing informal quotas by giving the Japanese to understand that if they don't accuse us of protectionism we won't make tighter formal ones.

posted by: David Weisman on 09.04.04 at 10:37 PM [permalink]

I have a question and I was hoping someone here could answer it.
France's government spending is at 54% of GDP, what is the US percentage?
I think it is around 5-10% but can't find the right site for an answer.

posted by: Mark on 09.04.04 at 10:37 PM [permalink]

The article goes in circles.

The Asian tigers have highly manipulated markets and processes, with closed markets to U.S. and for many years.

Free enterprise, invisible hand, etc. is archaic. It doesn't work except in the ivory towers-- which many of us feel needed knocking down thirty five years ago before this country was ruined entirely. Idiocy who wouldn't listen to many of us smarter and with much more savvy as Januses. Same too for all the paper professionals and Darth Vader attorneys as univ end products manure who have ruined and hemorrhaged the country. Can add funny money as investments into the manure.

So much idiocy for this Janus, that I for one can't stand what they have done to the country and can't stand what I have had to put up with knowing better as one of the Januses.

posted by: Alex on 09.04.04 at 10:37 PM [permalink]

Look at the historical tables of either the US Budget or the appendix tables in the CBO Budget and Economic Outlook. 20% is the recent average, but that's for federal government - if you want state and local added in maybe you can check out Norquist's org, Americans for Tax Reform, for a nice large number (I think it includes their "estimate" of the cost of regulation, too).

In either case, I don't think we should be getting up in arms about foreign governments spending $ on industrial policy because it comes from their taxpayers. You might be able to argue that this raises net saving in these countries, but surely it is poorly allocated since returns aren't the primary concern when this money is spent. Rather, they spend money to keep firms afloat and avoid mass layoffs (if I have got the pulse of the Continental financial news correct).

posted by: Matt on 09.04.04 at 10:37 PM [permalink]

James Fallows' 1994 book -Looking at the Sun- introduced me to the protectionist arguments of Friedrich Last. A good argument can indeed be made that a nationalist industrial policy might have worked in the early stages of economic development---of the distant past. There is a major reason why it cannot do so today. We live on a small planet where information is instantaneous, and it is far more difficult to to prevent the buyer from learning about a better deal down the road. In the long run, industrial policies are inevitably doomed to fail. Politicians and other outsiders are simply unable to respond adequately to subtle changes in the marketplace. By the time they realize the problem, it’s too late to make the necessary changes. The crisis overwhelms them. Only insiders directly impacted will constantly keep their ear to the ground.

posted by: David Thomson on 09.04.04 at 10:37 PM [permalink]

Export promotion and selective protectionism would not have been contradictory policies for any of the East Asian economies. They also would not have been successful in generating as much growth as they did without the access East Asia had to the enormous American market (and to some extent to large quantities of Japanese capital invested to serve the enormous American market).

By the criteria in the IIE working paper the most successful example of American industrial policy was the Defense Department's sponsorship of the Internet. Neither DoD nor anyone else foresaw where that sponsorship would lead, nor was government support of the Internet intended to produce the results it did. It was essentially an accidental policy, something we ought to consider when pondering the likelihood that future attempts at industrial policy will lead to success.

posted by: Zathras on 09.04.04 at 10:37 PM [permalink]

“Neither DoD nor anyone else foresaw where that sponsorship would lead, nor was government support of the Internet intended to produce the results it did.”

That’s right. It was a totally inadvertent result. As matter of fact, I believe the first messages over the Internet dealt with the need to feed the family cat! It took the “inventors” awhile before putting the Internet to truly practical purposes.

A bureaucrat, no matter how wise, cannot posses adequate knowledge to run a business on a day to day basis. This is the fatal flaw of socialism. We have enough trouble handling our own affairs. Only an very arrogant individual thinks themselves capable of being an expert on virtually everything. On top of that, political considerations often come into play when a particular industry needs to die! Those who are directly impacted will usually find any silly excuse to keep the business going. A viable and growing economy must create jobs---and allow some to die off.

posted by: David Thomson on 09.04.04 at 10:37 PM [permalink]

Think about a hypothetical horse and buggy industrial policy during the early years of the automobile. Bureaucrats and politicians would have likely persisted to support the former industry regardless of the promise of the new. They may have even perceived the car as a threat which must be destroyed. After all, the automobile made a lot of noise, could run over people, and maybe was even diabolical. Did God even want human beings to be able to move around so freely? Can you imagine what some teenagers might do in the back seat of a car? Yup, we’ve got to stop this foolishness before it goes any further! Horse are natural---and automobiles are mechanical monstrosities.

posted by: David Thomson on 09.04.04 at 10:37 PM [permalink]

Hipshot unsupportable comment incoming:

I recall reading that successive UK governments spent so much money propping up the lamentable British car manufacturers that it would have been cheaper to buy every citizen a nice new Toyota.

Perhaps the question is, of the hypothetical 'three countries' which successfully picked a winning industry to sponsor, how many just arsed it? If everybody's throwing money around, surely somebody's going to get lucky at some point. There's a lot less luck involved in restraining government expenditure... and probably a lot less votes.

posted by: fidens on 09.04.04 at 10:37 PM [permalink]

Think about a hypothetical horse and buggy industrial policy during the early years of the automobile. Bureaucrats and politicians would have likely persisted to support the former industry regardless of the promise of the new.
And again, I think you have to take a hard look at EADS. They succeeded in driving McDonnell-Douglas out of the airliner business, have fought their way from 0% market share to 52% against their one remaining competitor (US-based Boeing), have more-or-less shut the US out of the turbine-engined helicopter market in Europe and leveraged that into the US market, and are now making serious inroads on the military side (the Eurofighter may end up being a dog's breakfast, but the A400 is another story).

All that while being the most blatent recipient of industrial policy since Chrysler. You can talk all you want about how this will hurt the Yurp'eans in the long run, but in the medium run it is devestating the US.


posted by: Cranky Observer on 09.04.04 at 10:37 PM [permalink]

David Thomson, you have a point.

Given a choice between a giant private corporation and a government, neither of which can respond adequately to subtle changes in the market, better to let the corporation fail and go bankrupt.

If the government gets involved it might put more resources into the failure than the giant corporation has. So if you're pessimistic about government, you'll figure better to let the bureaucrats in the giant corporations do the planning than the government bureaucrats.

Even if you have smart planners the politicians are likely to step in and make you try to save failing industries. It's hard.

On the other hand, if you don't do planning, won't the same politicians step in and try to bail out failing industries? Won't they try to prop up giant corporations that are in trouble? Maybe the problem isn't the planning, maybe it's the failing giant corporations and the failing industries and the politicians, all of which we'll still have with no planning.

Fidens, here's my thought. If a bunch of governments do planning and most of them pick losing industries to back, those nations will be behind. And if a few of them back winning industries at random, those nations will be ahead. Their winning industries will beat the same industries that didn't get any backing in your nation.

So if it's like that, there's no good way to arrange to be a winner. If you don't do planning the ones who do and who luck out will beat you. If you do planning, chances are you'll do it wrong and you'll be even worse off than if you hadn't.

The only way to win is to buy a planning ticket and be lucky.

Or if you can persuade enough other nations not to plan, there will be so few random planners that they mostly won't get lucky and you can win by other methods.

posted by: J Thomas on 09.04.04 at 10:37 PM [permalink]

The most likely answer is that neither mechanism does much of anything, but their presance is evidence that industrial development is acceptabe politically. The good business climate will incourage (re)investment, leading to sustained progress regardless of the theoretical motivations.

posted by: Eric M on 09.04.04 at 10:37 PM [permalink]

You've got to look at the macro as well as micro effects of industrial policy. Dani Rodrik's argument is that if you adopt selective protection and export promotion, your development will tend to be financed more by domestic than foreign saving, and that this matters.

posted by: dsquared on 09.04.04 at 10:37 PM [permalink]

My experience in Taiwan is that the government ends up supporting larger firms than smaller, and these tend to be the already successful. It's a case of C.Y.A.

They also follow trends as per the poster who mentioned his local government fixating on "high tech." We're supposed to be working for a "green silicon island" here - oh, except that chip fabs produce tons of toxic PCB's. There is a cult of worship for tech companies, when Taiwan's largest shoe company actually makes higher profit margins. (and without any goodies.)

And of course, all these industries who got free land, tax breaks, etc., many have now moved operations to China...not very useful national policy if your success stories close shop and move to another country.

posted by: Aaron on 09.04.04 at 10:37 PM [permalink]

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