State industrial policy: when it works, and when it doesn’t

DSC00236Will Hutton gets passionate about the failure of laissez-faire ideology in UK economic policy-making. He harks back to the heyday of interventionism during World War II and the post-war period. Of course, the right likes to think of this as the time when the UK economy was in decline. In fact, we had full employment, no major financial crises and prosperity was more widely shared than before or since. Growth in output and productivity was only poor relative to our competitors in Europe and Japan, many of whom were rebuilding after wartime destruction and ‘catching-up’ with the technological leader, the US.

State interventionism and industrial policy in particular can work, but not always. One can always pick and choose examples to back up one’s argument. After WWII, Japan, South Korea and Taiwan all went through periods of rapid growth. The policies varied somewhat, but all relied on some mixture of the protection of infant industries followed by strategic integration with the world economy once those industries were competitive enough to export successfully.

What seems to be important in an industrial strategy is for the state to lend conditional, time-limited support to particular sectors or industries, with the proviso that the support will be withdrawn in the absence of sufficient price competitiveness. The latter will tend to be achieved if companies achieve rapid productivity growth, which requires investment in technology and in the labour force. This is necessary for ‘learning-by-doing’ to take place, so that workers and companies are able to accumulate the knowledge required for producing successfully for domestic and international markets.

In the absence of productivity growth in the supported sectors, state support needs to be withdrawn after a certain period, in order to avoid the long term welfare losses associated with poor performance. Obviously this requires judgement on the part of policy-makers, which will necessarily be imperfect. But the state needs to have a certain credibility so that it is not captured by poorly performing firms and their owners and managers. There will always be economic costs to supporting new firms and sectors, but an industrial policy can be justified if the longer term if the benefits of this support to the economy as a whole are much greater than the costs.

The article by Hutton makes the case for state intervention in industry but does not address the potential for failure. He is offering as limiting an argument as those on the right who reject intervention altogether. The first best solution in many developing countries is a successful industrial policy. This may also apply to advanced countries. The worst outcome is a failed industrial policy. The outcome of laissez-faire lies somewhere in between.

The difference between successful and failed industrial policies lies in the different politics and the balance of power between the state, the private sector and other groups in a particular society. The state needs to avoid the capture of the rents it creates in the sectors it aims to promote. So it is naïve to engage in a purely economic analysis, without examining the lessons of history and cases of industrial policy success as well as failure. There is a need to incorporate these lessons and engage with the political economy of development, in rich countries as well as in poor ones.

The form industrial policy might take in rich countries closer to the technological frontier will of necessity be different to that attempted in poor countries which simply need to begin industrialising. But the idea that the state can promote the accumulation of knowledge and the resultant productivity growth through temporary support for particular sectors remains important. Will Hutton’s piece tells only part of this story.

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