Governments can pick winners (Ha-Joon Chang’s Thing 12)

23-things-they-don-t-tell-you-about-capitalismThis post continues an occasional series based on chapters in Ha-Joon Chang’s book 23 Things They Don’t Tell You About Capitalism. Chapter 12 aims to counter the idea among free market economists that the government should not be in the business of supporting particular firms or sectors, and should leave things, as far as possible, to the market. In other words, if industrial policy is at least partly about ‘picking winners’, then ministers and bureaucrats should stay out of the way, as those in business will inevitably know more about how to achieve economic success.

Chang notes that there are plenty of examples from across the world in the history of capitalism of the successful picking of winners by the state, from South Korea to the US. In another part of the book, he points out that what is good for one particular firm may not be good for the economy as a whole. After all, economic growth and development under capitalism involves a process of creative destruction and structural change, as some firms succeed and others fail, expanding and creating new jobs in some cases, and stagnating or shrinking in others, going bankrupt or being taken over and restructured, with jobs being lost. There is constant change in a successful economy, and this is essential to rising productivity and overall living standards. If the state can play a role in facilitating this process, then this may involve intervention and not simply deregulation and leaving it all to the market.

South Korea is a case in point. The government, with some help from Japan, set up an integrated steel mill in the 1970s, despite being one of the poorest countries in the world, and having to import the necessary raw materials. It was state-owned, and run by a former army general, and the venture went strongly against the comparative advantage that the theory of international trade said should determine the direction of production. The firm received free infrastructure, tax breaks and all sorts of subsidies. To cut a long story short, by the 1990s, it was one of the world’s leading steel companies, and was privatized in 2001, though for political reasons rather than poor performance. It remains the fourth largest producer of steel in the world, by output.

This is one example of state success in picking winners. The South Korean government’s industrial policy in the post-war period is credited by many economists with turning a very poor country into a rich one in a few decades.

There are of course examples of state failure in industrial policy, such as the Franco-British super-sonic airliner Concorde, which although a remarkable feat of engineering, was something of a white elephant. While Japan, South Korea and Taiwan achieved ‘growth miracles’ and rapid development over a prolonged period, arguably through different forms of state intervention and picking winners, economies in South Asia were less successful, and despite organising support for particular sectors, did not grow as fast; in fact, the state ended up supporting firms and industries which did not become internationally competitive and which led to merely wasteful subsides and consequent welfare losses.

One of the differences with the East Asian economies was that their respective governments were able to withdraw support from firms and industries when it was clear that the latter were not going to be a competitive success. Infant industries that failed to ‘grow up’ were allowed to fail, and support was reallocated to new areas. And far from the relevant state bureaucrats being experts on industrial development, they adopted an experimental approach, learning from successes and failures of particular policies, and adjusting policy accordingly.

Even in the US, the post war military-industrial complex and public sector research more widely has supported the development of numerous new technologies, which have found civilian uses.

In all these countries, as already mentioned with regards to Concorde, there have been cases of picking losers, firms which were not an eventual success. But this is surely a poor reason for the state not to engage in industrial policy. As Chang says, governments need to ‘improve their batting average’, and reduce the ratio of losers to winners, through a process of experimentation and learning.

There is a further aspect to consider when governments try to operate a successful industrial policy, alluded to briefly above: their capacity to withdraw support from firms which are proving unsuccessful. My old MSc tutor Professor Mushtaq Khan of SOAS has researched this in some depth and has argued that the balance of power between different organisations in society is a key determinant of industrial policy outcomes. He calls this the political settlement, which necessarily varies between countries depending on their particular history. This means that different political settlements will require different forms of industrial policy in order to achieve successful development. A state needs to be able to threaten credibly to withdraw support in the case of business failure, and also in the case of success, when a firm or sector is competitive enough to function independently. This will provide the right incentives which encourage firms to engage in organisational learning and the acquisition of the necessary capabilities in order to produce rapid productivity growth over time.

So industrial intervention is not purely a question of economics and the ‘right’ policy. Politics matters too. Different countries with different political settlements will need different policies in order to achieve success. A key point is that winners are being picked all the time in both the public and the private sectors, as well as in joint ventures between the two.

History shows that state industrial policy has great potential both to accelerate development among poorer nations, and to sustain growth and technological advance among rich ones. But there is the potential for expensive failures, so a careful attitude of experimentation among policy-makers is vital, alongside an assessment of what sort of policy and which firms and sectors have the potential for success given the balance of power in society.

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