Industrial policy: sounds good, but it’s unhealthy

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Industrial policy is all the rage in Western political circles these days. In the United States, the CHIPS and Science Act builds on the 2021 Innovation and Competition Act. Both bills begin with nearly identical text, as their goal is to support “semiconductor manufacturing, research and development, and supply chain security.” Under these initiatives, the federal government is authorized to spend more than $50 billion over the next decade to fund the construction of new semiconductor chip factories in the United States. A strong stipulation of the funding is that recipients of such funding will not be able to scale up their production of advanced chips in China.

The United States is by no means alone in its offer. From the European Union to a number of Asian economies, subsidies, tax incentives and public-private partnerships are on the menu to support domestic high-tech manufacturing. There are many precedents that are considered instructive, from China’s massive allocation to defend national industries in recent decades to Japan’s notorious Ministry of International Trade and Industry in the 1960s for subsidizing research and national development to rely on foreign technologies.

But economic historians point out that the experience of industrial policy is mixed at best. Five decades ago, the fallout from Japan’s industrial policy interventions on the textile and mining sectors was not promising, while even successful entrepreneurs who enjoyed public sector support complained of government intervention. excessive. Moreover, as evidenced by successive episodes, whether in Japan in the 1980s or in the United States today, successful market share gains by sectors or foreign companies have led to a chorus of protests from domestic competitors who then lobbied for their own quotas and subsidies. , creating a cycle of trade friction and protectionism.

Can the public sector achieve significant success in choosing industry champions and supporting them with incentives? It is tempting to look at the experience of East Asian economies and see the wisdom in intensive public sector involvement in promoting basic and applied research. But the East Asian experience is not a complete success. In addition to Japan’s failure to protect the mining and textile sectors, China’s industrial policy has yet to materialize in major gains at the high end of the technology spectrum. Its track record in the semiconductor industry is characterized by tens of thousands of companies seeking government support, and only a few of this cohort have achieved breakthrough developments.

Industrial policy is difficult. It requires government officials with little or no specialized knowledge or expertise to track industry trends, identify potential market failures, resolve supply chain complexities, and coordinate various industry players. . There is an additional foreign policy dimension, which also justifies working with like-minded governments. On top of that, managers must avoid regulatory capture, cronyism, corruption, and misallocation of capital. History suggests that overcoming these challenges is exceptionally difficult; they either lead to reckless funding or exceptionally conservative decision-making, with the midpoint often elusive.

As seen in the United States over the past two years, when support for industrial policy rallies, so does a wide variety of political interests. There are many cases where grants are tied to the use of domestically sourced technologies and components, and where foundations and universities must take into account a myriad of considerations, from rural development to poverty reduction. , before spending on research. As lofty as these goals are, when it comes to the highly competitive field of high tech, it might be best to keep the goals clear and simple.

Several billions are needed to develop the latest generation of semiconductors. American chip companies made the strategic decision decades ago that the most profitable combination was to focus on domestic design while outsourcing manufacturing. This led to massive corporate profits, but presented an uncomfortable visual of the declining US global share of chip manufacturing.

Today, in an effort to create domestic jobs and increase global share, huge amounts of taxpayer funds are being allocated to subsidize those same companies that called decades ago to produce elsewhere. What will the apparent return of jobs and gains from domestic production bring? Maybe some political capital under the notion of a more resilient supply chain. What will be lost in this huge effort is the opportunity to promote multilateralism, efficient capital allocation and a truly competitive and vibrant private sector.

Beyond the thirst for resilience, there have been other drivers that have set globalization back, in particular the stark rise in inequality. It is doubtful, however, that industrial policy, which is largely oriented towards large companies, can solve this problem. Arguably, progressive tax and wage policy, better-targeted job training and social safety nets would help reduce inequality far more effectively than massive subsidies to tech giants. The gains from globalization have not been equal and some course correction is warranted with respect to national security and intellectual property protection. But the current trend is worrying and risks reversing the gains from trade over the past decades.

The danger of devoting so many resources to industrial policy goes beyond inefficient capital allocation and reversal of the gains from trade. The weakening of multilateralism undermines the ability to deal with global issues, those that hover far above great power rivalries. From climate change to the pandemic, existential issues require urgent global cooperation. These historical challenges will remain insurmountable if nativist policies keep resources and ideas locked within certain borders.

The public sector plays an exceptionally important role in promoting basic research and building physical infrastructure and human capital. Investments in education, science-based enterprises, health care and climate change are the elixirs of productivity and long-term prosperity. There is enormous scope and promise for state intervention in these areas. The selection of future industrial winners is not one of them.

Taimur Baig is Chief Economist, Group Research, DBS Bank.

This article was originally published in the Bulletin de l’OMFIF, autumn edition.

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