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.

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. 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.

That is why economists of all political persuasions agree that governments should fund basic science and technology. When I chaired the Council of Economic Advisers for President George H.W. Bush, we doubled the budget of the National Science Foundation. 

Governments, however, risk crowding out private R&D, the returns from which could be fully appropriated by firms, not only through their own use, but by patenting and licensing the technology to other firms.

The appropriate place to draw the line conceptually is at pre-competitive, generic science and technology. Governments should fund R&D until it reaches the stage where private firms could appropriate (the bulk of) the benefit.

For example, the computer-linking technology that created the Internet was funded by an agency of the US Defense Department. But it would be foolish for the government to subsidize a particular search engine or social-networking platform.

Governments should not be in the game of using subsidies, taxes, regulation, mandates, loans, and investments to pick particular winners. It simply doesn’t work, and, worse still, it crowds out or stifles potentially valuable competing technologies.

While firms and investors take the funds, private financing for commercial alternative-energy projects is widely available; an immense number of venture-capital funds worldwide are devoted to alternative and clean energy.

Government should set general goals for energy and the environment and then let entrepreneurs, investors, and consumers decide how best to achieve them.

It should fund basic scientific and technological research applicable to these issues. But no policy makes sense if it cannot be sustained without long-term government support.

Whatever the dubious temporary merits of reviving industrial policy in a deep recession, governments need an exit strategy before the programs become permanently entrenched and develop powerful rent-seeking constituencies.

Vast amounts of debt-financed spending will require higher future taxes, which will divert capital and labor from higher-value uses than can be sustained without permanent government lifelines.

Industrial policy failed miserably in the 1970’s and 1980’s. Allowing governments to pick industrial winners and losers is just as bad an idea today.

Michael J. Boskin, a former chairman of the US President’s Council of Economic Advisers, is Professor of Economics at Stanford University and Senior Fellow at the Hoover Institution.

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