Is Industrial Policy a good idea?

Industrial Policy is back—or so Dani Rodrik proclaims. Several European countries openly advocate the government promotion of particular industries, while the World Bank’s chief economist now supports industrial policy for developing economies. America, too, is flirting with increased government intervention in firms, through various green initiatives.
Yet the debate over industrial policy remains simplistic. Advocates frequently point to countries that support industrial policy—such as China or France—and observe that these countries are rich or growing. Industrial Policy is presumed to be the cause of their growth, and it is pronounced a success.

There are many problems with this analysis. As William Easterly notes, it is important to get the comparison right. France might be doing even better if its firms had less state interference. A better analysis would examine all countries that try industrial policy—including the failures—and examine their relative success.

There are also a variety of non-GDP related costs associated with Industrial Policy that are difficult to nail down. To see this clearly: take the contrasting story of cell phones in India and China.

In India, the telecommunication sector shows the success of privatization. As long as a state-run firm handled phones, few people had landline access. Auctions of telecom licenses led to this huge burst of investment and innovation. The so-called “Indian Model,” that resulted delivered the world’s lowest cell phone prices and the mass adoption of cell phone services.
By contrast, China’s telecom policy has been based on the idea of getting state control over the commanding heights of telecommunications. Companies like China Mobile dominate cell phone services, while companies like Huawei are growing giants in telecom hardware. Judged from a pure economic standpoint, this type of state control is compatible with high rates of economic growth. These state-sponsored companies are also highly profitable.

But state control comes at a cost. China has higher cell phone rates, and texting is more popular partially as a result. International corporate acquisitions are also affected. India’s Bharti—a top private mobile operator—has purchased Zain, another private African mobile operator. Bharti plans on exporting its low-cost outsourcing model there, potentially revolutionizing African telecoms. State strategic interests, on the other hand, motivate China’s acquisitions. India’s competitive environment may be better geared towards generating internationally competitive firms.

The hidden costs of industrial policy may not show up on a simple economic ledger. But they are real nonetheless. If the past few years have shown private industry at its worst—think AIG or BP—it’s not clear that injecting more government control would produce better results.

More New South

Thanks to those of you (especially Chris) who had things to say about the South.  To the left is some data that gets at the point I'm trying to make.  You have a graph of per capita personal income growth relative to 1948--so this is measuring post-WWII regional disparities in growth.  The Southern states appear to be moving in unison faster than the other plotted "blue" states like California and Illinois.   

Obviously, some of this is catch-up, as the South was relatively undeveloped for a while and then various changes made it economical for companies to take advantage of the income differential.  But the development literature is also clear that convergence requires meeting certain hurdles.  Going back to 1948, armed with knowledge of future trends in services, manufacturing, and agriculture, I think you'd be hard pressed to imagine the South as a leading area of growth in the country, but that's in fact what has happened.

So then the question is why did this happen.  Here is a long list of potential explanations, implicating among others a big push in infrastructure, human capital development (the Rockefeller-funded hookworm and malaria eradication projects were also useful), climate, and of course AC.  I find these explanations slightly ad hoc and they really seem to beg the question, while also better at explaining the earlier takeoff rather than the current trajectory.  My suspicion is that within a country like the U.S., state-level institutional differences explain at least some of the difference.  

And there is in fact a political explanation which largely makes my point by arguing that the breakdown of the Democrat majority after 1960 spurred economic growth.  While I emphasized Republicans, the point is really more about the changing electoral dynamics and the growing political power of people who do not have quite the entrenched economic interests as people elsewhere in the country (though if I read the paper right, the Republicans do have a larger impact on growth).  So the argument is that the South grew because it got better political leadership which prioritized high-growth policies, though of course other things were involved.  

If you look at the right of the graph, you'll see that the growth gap appears large and growing (though blue states remain richer).  These are very partisan viewpoints, but they argue fairly convincingly that Southern states are doing well and Blue/Rust Belt states are not doing so well.  In some sense it's no surprise that the Chicago politician sees a bad economic climate and the Arizona senator sees good fundamentals.  Of course assigning causality is hard, but it's much easier on a state level--where governors can get legislation passed and attract businesses--than on a national level, where all one really has to do is not make too many mistakes and hope you get lucky.  

If you really believe these results, they point to a radically different American regional differentials.  This New Yorker article is an interesting view on Rust Belt/Appalachia and their future prospects.  They really don't look great, and I somehow doubt that Presidential politics--which was the focus of the piece--is really going to change that.  Of course, there are really two issues here.  One is the increasing regulatory and business advantage certain states hold, and the other is the continued breakdown of the American family.  The second is a lot more important--I know of no community in this country that doesn't prioritize stable families, education, and hard work that isn't doing pretty well for themselves--but the first is much more open to political change.  But again that comes from the grassroots, and the South was lucky in that it lacked the unions and pork and could jump ahead to the jucier bits of development.  It's hard to imagine this happening in many struggling states and cities, which seem to face single-party dominance and not much of a constitutency for change (more of the same?).  

The overall situation here seems to be a global trend, in which the world as a whole converges with substantial hetergeneity on political and cultural grounds.  India is a good comparison as a pluralist democracy with substantial political devolution of powers to states.  And you see the better run states getting better while other struggle.  Freer markets seem to accelerate this process; amplifying the gains while making it harder to deny people their rationalizable worth.  Many people see a "race to the bottom" but optimistically, the incentives are there for everyone to govern and produce better.

Industrial Policy

Dani Rodrik's latest book--One Economics, Many Recipes--is one of the best I've read recently. The nature of book-binding fits manuscripts to a certain page rage, regardless of the actual length needs of the discussion. Combined with poor writing and editing, a majority of books contain a high fat/content ratio. I've wondered about the empirical distribution of that ratio and the theoretical minimum. On the basis of no analysis, I conclude that the fat ratio follows a gamma distribution, with a mean at around 60% fat tailing to a 15% minimum. I imagine 20% fat is around optimal; The Economist has somewhat more fat than this but is one of the leanest publications around. Fat-avoidance has shaped my shift from consuming books to size-constrained blogs and articles.

Rodrik's book is written as a series of self-contained articles, greatly lowering the fat count as each chapter makes stand alone claims. These are grouped into three sets, the third of which, on global institutional frameworks and similar esoterica, I will ignore.

The first set of arguments concern the failure of successive iterations of development policy. Rodrick concludes that a basic framework--proper competitive incentives, a good macroeconomic situation, globalized outlook, and social insurance--is common to all successful economies, but that particular institutional designs vary. Instead of the Washington Consensus transplant approach of grafting overseas best-practices over every local organ, Rodrik adopts an "optimize what you optimize" mentality; use diagnostics to identify the functional hurdles preventing the rise of the productive sector of the economy, and improvise local solutions. This is great stuff, worth more than the cumulative total of all economic randomized trials ever conducted.

The second bit covers industrial policy. As Tyler Cowen notes, the substance of his proposals is actually fairly limited, while the rhetoric of railing against fundamentalist economists is overblown and against the humble spirit of the book. This is because Rodrik has a strong agenda of normalizing industrial policy as another piece of the government tool-box.

Rodrik presents a sophisticated case for viable government interventions in a complicated world, but I am skeptical. The historical examples rely heavily on East Asian examples. It's fair to say that the debate over industrial policy is basically a debate over government practices between 1950-1970 in East Asian economies. Of course, in this period virtually every other developing country attempted industrial policy in some form or another and all of them failed. The key counterfactual is to what degree the peninsulas and islands of Asia would have prospered without industrial policy, and the pressing policy question is to what degree other developing countries can replicate such planning institutions.

I suspect that the success of Asian economies is due more to government success in human and physical capital, oppenness to foreign trade, and competitive markets rather than successful industrial policy; and that more pluralistic, democratic countries will find it difficult to replicate their institutional structures (these countries find it hard enough to deliver basic government goods) . Here are some critical assessments of Eas Asian industrial policy. In several cases, the bulk of government subsidy was not directed at the most productive sectors but rather the more politically sensitive ones. So in Taiwan you have government subsidized heavy industry while the small and medium scale firms did the bulk of the production, and in Japan you see large subsidies for rural development and the postal banks. Korean policy was perhaps the most extensive, but some people disagree that it was effective relative to doing nothing.

It's also worth pointing out that all East Asian post-WWII successes were ethnically homogeneous, and were either city-states with strong British influence (Singapore, Hong Kong) or former Japanese colonies (Korea, Taiwan), giving these countries strong legacy institutions.

Rodrik also commends China and India's gradualism. But, given their large disparity in income relative to developed countries, convergence was inevitable and the question is how much did gradualism help economically, even if it was great politically. In China, much of the federal outlay was directed at Soviet-style large industry, while the small and medium size firms that drove the economy were more independent (though they maintained close ties to local Party officials). Indian industrial policy was absolutely catastrophic, and success in biotech and information technology is due greatly to the fact that these sectors did not exist when regulations were drawn up. The scope of Asian markets will continue to attract business regardless of failure or success of government policy.

I do see the potential for market failure, and Rodrik details some plausible scenarios. Much like how the path of immigrant migrations follows the intitial migrants rather than the fundamentals, corporate development tends to follow the path set by the first-movers. But the potential for government failure is also strong, and I am skeptical of the degree to which future governments can target the money properly. Broad-based, universally accessible policy such as research, investments in education and infrastructure, and a pro-growth, low tax environment lift all boats, but is perhaps better discussed under the label of "good governance" than "industrial policy."