Industrial Policy: A Global Review

Trump has made industrial policy one of the defining features of his second administration. Historically, conservatives and Republicans have, at least in theory, been skeptical of using industrial policy to tinker with the economy. That has changed. And more articles and books are being written about industrial policy.

One such book is Marc Fasteau and Ian Fletcher’s Industrial Policy for the United States: Winning the Competition for Good Jobs and High-Value Industries. Although the general tone and thrust of the book seems misguided, it is not without its merits. While one could use the 600+ page book as an excellent door stop (and non-economists probably should), Fasteau and Fletcher have done a lot of homework from which the student of economics can learn. 

Fasteau and Fletcher claim that a policy of pure free markets and free trade is fanciful, simplistic, and deeply unhistorical. They argue at great length that government intervention, industrial policy, has played a central role in every successful economy. Intelligent interventions and policies worked for Japan, South Korea, and China. They were also present in important ways in American and British history. 

Of course, the authors acknowledge that industrial policy can fail dramatically and give some examples. They also rightly note that the abuse or misuse of a thing does not mean the thing cannot be used properly. If industrial policy can succeed, then the goal of policymakers should be to craft a successful industrial policy. Industrial Policy for the United States purportedly gives them a comprehensive guide on how to do just that.

The book begins with a couple of theoretical chapters describing and advocating industrial policy while criticizing simplistic laissez-faire approaches to the economy and trade. The authors then launch into detailed case studies of the economic development and uses of industrial policies across many countries: Japan, South Korea, China, Germany, France, Britain, India, and Argentina. They devote a whole section of the book to various eras in U. S. economic history. To their credit, the authors don’t only cherry-pick highly successful industrial policies. They also talk about shortcomings and failed industrial policy.

Each case study presents numerous examples of industrial policies. Special lending facilities, privileging “national champions,” restricting investment flows, manipulating currency valuations were all used at different points by the Asian Tigers. The U. S. also had a host of tariffs throughout its history, as well as its fair share of subsidies and regulations. Though to call the U. S economy generally state capitalism would be a stretch. Still, during some wars, during the New Deal, and after WWII, it has seen extensive expansions of government agencies and policies into the U. S. economy.

One can formulate two different propositions from the book. Is government policy important for healthy economic development? And does it have essential connections to every sort of market and business activity? The authors make a compelling case that the answers to those questions are “yes.” But most free market economists would also agree with such claims because good institutions and the rule of law are essential preconditions for healthy markets. 

Stable currency, clear enforceable property rights, free speech, fair tort systems, even significant infrastructure and public goods provision, all these can contribute to healthy market activity. If this is all Fasteau and Fletcher want to argue, they would find themselves in broad agreement with those they claim to criticize.

If, on the other hand, Fasteau and Fletcher want to make the case that governments ought to take a very active role in economies – directing capital, subsidizing borrowing, restricting imports and exports, imposing capital controls, and investing directly in “important” companies and industries, their success is at best mixed. They face two related challenges: the problem of the counterfactual and the problem of correlation.

Did South Korea’s explicit government support of business conglomerates (Chaebols) contribute to its rapid economic growth? How much did Japan’s restraints on imports and subsidized lending to domestic industries help its economy to industrialize? The authors might acknowledge that we can’t know the answers for sure, yet clearly, these countries had really impressive growth. So such industrial policies, at the very least, couldn’t have reduced economic growth too much. That might be a fair point - though the Japanese government concluded that its industrial policy did, in fact, slow its economy. In 2002, Japan's Ministry of Finance published a review of the industrial policy of Japan from the mid-1950s through the 1980s and concluded, "the Japanese model was not the source of Japanese competitiveness but the cause of our failure."

Even if it were true that industrial policy did not have a largely negative effect in other countries, the point is minimal because, as the authors note, countries develop at different rates and with different specialized industries. They argue that industrial policy must be tailored to individual countries rather than follow some universal economic blueprint. Their work is not so much a theory of industrial policy as it is an attack on existing economic theory.

In place of economic theory, Fasteau and Fletcher suggest a toolbelt approach to economic policy. They offer the following list of about two dozen industrial policy tools:

• Infant-Industry Protection
• Local-Content Rules
• Stage-Differential Tariffs
• Import Substitution
• Selective Importation
• Export Subsidies and Targets
• Incentives for Foreign Firms
• Export Processing Zones
• Regulatory Competition
• Credit Allocation
• Forced Savings Policies
• Sovereign Wealth Funds
• Government Procurement
• State Entrepreneurship
• National Champions
• Imposing Competitive Industry Structure
• Fostering Clusters
• Supporting the Industrial Commons
• Supporting Private Research
• Supporting Public Research
• Intellectual Property Policy
• Standards Setting
• Technology Mapping
• Technology Denial
• Combining Policies
• Picking Winners

But how can we determine which tool(s) fit our current moment? Perhaps more importantly, who will make that determination, and can we have any confidence that they will choose policies based upon economic efficiency or reasonable measures of the common good? History, experience, and theory suggest that believing countries will or can regularly choose “winning” industrial policies requires a huge leap of faith.

The famous economist Alfred Marshall had concerns about industrial policy, even if one could demonstrate its superiority in limited cases:

I ​found that, however simple the plan on which a protective policy started, it was drawn on irresistibly to become intricate; and to lend its chief aid to those industries which were already strong enough to do without it. In becoming intricate it became corrupt, and tended to corrupt general politics. On the whole, I thought that this moral harm far outweighed any small net benefit which it might be capable of conferring on American industry in the stage in which it was then.

​Subsequent observation of the course of politics in America and elsewhere has strengthened this conviction. It seems to me that the policy adopted in England sixty years ago remains the best, and may probably remain the best, in spite of increasingly rapid economic change, because it is not a device, but the absence of any device. A device contrived to deal with any set of conditions must become obsolete when they change. The simplicity and naturalness of Free Trade—that is, the absence of any device—may continue to outweigh the series of different small gains which could be obtained by any manipulation of tariffs, however scientific and astute.

Even if a country stood to gain from a narrow, well-tailored industrial policy, the upside compared to “laissez faire” market outcomes is limited. The downside, however, can be huge. Europe presents a cautionary tale of uncritically accepting Fasteau and Fletcher’s recommendations. The authors often conflate failed industrial policy with “free market” economics. European countries haven’t stagnated because they were too “market fundamentalist” and somehow missed the industrial policy boat. They have had a host of industrial policies for decades that have stifled innovation and hindered economic growth. 

Blaming slowing growth rates and declining manufacturing on the “free market” seems like a stretch. We could claim that countries made the “wrong” industrial policy choices, but that begs the questions of why and how smart people didn’t arrive at the “right” policies. And what reason do we have to expect anything different in the future?

Although the authors argue that economic theory is not a reliable guide to policy, they acknowledge the importance of reasonably sound economic theory. None of the successful Asian Tigers could have succeeded without broad market institutional reforms, even if imperfectly. They needed property, prices, profit, and loss. They needed to allow innovation and trade, at least to some extent, with the rest of the world. 

Furthermore, Fasteau and Fletcher fall prey to an overly narrow view of economic growth and success. They focus on particular industries and certain kinds of output to show successes and failures of industrial policy. Yet the real challenge of a healthy economy, as Hayek pointed out, is not how to maximize or optimize specific kinds of output. Instead, healthy economies lead to vast amounts of discovery of what people want, what resources are available, and how those resources can be coordinated between production and consumption to satisfy millions of desires and plans simultaneously.

For the serious student of economics, this book offers detailed case studies of economic development. It also provides many opportunities for advocates of free markets to grapple with the various ways government policy can influence markets. The book also presents a substantive foil for contrasting a theoretical approach to understanding the economy with a historical piecemeal view of economic development. 

But I would not want to see this book in the hands of policymakers because, as Adam Smith observed 250 years ago,

The statesman, who should attempt to direct private people in what manner they ought to employ their capitals, would not only load himself with a most unnecessary attention, but assume an authority which could safely be trusted to no single person whatever, and which would nowhere be so dangerous as in the hands of a man who had folly and presumption enough to fancy himself fit to exercise it.

The simple system of natural liberty that Smith and many other economists have advocated over the centuries is a far surer guide to prosperity and economic dynamism than tailored industrial policy shots in the dark. Relatively free markets and relatively free trade have brought about unprecedented economic growth and prosperity around the world. We should be very hesitant to depart from them.

Paul Mueller is a Senior Research Fellow at the American Institute for Economic Research. He received his PhD in economics from George Mason University. Previously, Dr. Mueller taught at The King’s College in New York City.