Industrial Policy

A question I had in my head today that I thought would be good to write about is this – why do some countries/jurisdictions engage in activist or interventionist industrial policies, as opposed to pacifist industrial policies a la neoclassical economics?

While this is not strictly based on the academic evidence, my research and thinking to date point to a few rationales. (Note: They are not mutually exclusive.)

1. National/Political Will – Thinking about so-called late industrializers like Germany, Sweden, and Canada, why is there so much variation between these countries in terms of their industrial policies? Based on these three examples, one can find commonalities in two of these countries (e.g., sense of nationhood; a common or manufactured historical narrative that created a sense of community; a historical legacy of “exceptionalism”, etc.). Of course, I am speaking about Germany and Sweden. While I am no expert in German unification, proto-German entities like the Holy Roman Empire and the Hanseatic League are presumably seen as antecedents to modern Germany. More clearly for Sweden, the imperial successes of Sweden is likely a source of pride for some Swedes, and perhaps motivated a more active approach to industrial policy. Obviously, Hamiltonian policy in the US is another example. Contrast this with Canada, where ethnic nationhood has always been weak (which is one of the country’s social strengths), but may have come at the cost of a cohesive economic vision. While there have been periods of coherence (e.g., building of the railways post Confederation; the “National Policy” of more than 100 years), they may have been more rhetorical than a concrete vision.
2. Political/Security Dilemmas – The Meiji Restoration in Japan and its subsequent entry into activist industrial policy seems like a good example of this rationale. It also seems like Singapore falls into this category following the break with Malaysia in the 1960s. The US Chips and Science Act and the Inflation Reduction Act seem to fall into this category, though it may be too soon to tell.
3. Global Macroeconomic Instability – I may explore this in a future post further, but this is the rationale that I was thinking of the most today. Neo-mercantilist policies of countries like Germany, Japan, and now China seem to be a rational response to the disorderly way the global economy is organized. As Keynes indicated during the Bretton Woods negotiations, the system created by Harry Dexter White has led to political imbalances between creditor and debtor countries that overwhelmingly favour the creditors, unless you issue the global reserve currency (i.e., the US). Why have the Chinese followed the path that they have? As others have pointed out, the experience of the Asian Financial Crisis must have been alarming for the Chinese to watch, seeing that capital flight could lead to serious political repercussions and national embarrassments. German memories of hyperinflation seem to resonate still in the minds of policy makers – otherwise why would they depress living standards via the Hartz Reforms?

I wouldn’t say this list is comprehensive, but it gives us a good framework to group countries.

Of note, the Anglo-Saxon economic policies of Canada, Australia, New Zealand, Ireland and the UK from Thatcher onward seem not to have been informed by any of the above. While surely national pride is significant in Ireland, this does not seem to have translated into activist industrial policies resulting in a strong base of domestically-owned multinationals. Rather, this lot have generally deindustrialized, financialized, engaged in “race to the bottom” taxation policies, and in the case of Canada/Australia, been caught up in the commodity supercycle that helped gut their manufacturing sectors via Dutch Disease. Happy to hear if I am wrong about the ANZAC economies, but this lot does not seem to have been motivated by national will, or up until late, a security dilemma, and seems to have ridden the wave of global macro instability to tidy profits for the natural resources industries in Canada and Australia and financial services in the UK. Contrast this with countries like Germany, South Korea, Taiwan, Israel, Sweden, Finland, Singapore, Japan, China, and sometimes the US, who for some or lengthy periods of time, have been motivated by the above factors to engage in a more hands-on approach to their domestic economies.

When reviewing my collection of literature on the subject of industrial policy in search of a definition, it quickly dawned on me on how complicated this simple question was. More than likely, I will have to revisit this topic in a future post. But here goes nothing…

After reviewing about a dozen or so sources, it seems like they could be grouped into a few categories:

1. Highly simplified definitions;
2. Broad definitions that choose to focus on particular activities/actions for the sake of simplicity; and
3. Nuanced, robust, and complicated definitions (spoiler alert – I prefer these).

While Dani Rodrik is perhaps the academic most associated with industrial policy (?), in a 2008 paper, he uses quite a terse definition:

“Policies that stimulate specific economic activities and promote structural change.”

Well that is a start.

Equally terse is this one from the IMF from 2017.

“This departmental paper sets out a conceptual framework to analyze industrial policy, defined as targeted sectoral interventions.”

Definitely ranking in the middle category that I’ve outlined is from this Carnegie Endowment paper.

“For the purpose of this short note, industrial policy is defined as government intervention in a specific sector which is designed to boost the growth prospects of that sector and to promote development of the wider economy. I exclude (emphasis added) from this definition horizontal policies, such as investment in education, reinforcement of the rule of law and property rights, and so on, even though these horizontal policies can affect different sectors differently and so can be part of an industrial policy. I do so for the sake of brevity and because the importance of horizontal policies is widely understood, and there is much less controversy surrounding them than around sectoral interventions. To sharpen the focus further, I also exclude interventions at the sectoral level which aim to achieve other objectives than growth and employment, such as improving environmental and safety standards, as these interventions aim to correct well-recognized market failures and are also relatively uncontroversial.”

So now we’re getting somewhere. As opposed to sectoral interventions identified in the first two quotes, here we see some existential debates about industrial policy. Unfortunately, while the author sees the debate, the answer is to chop off the parts that are contentious, and focus on the easy/non-controversial aspects: sectors, growth, economy. Helpful to some extent, but again missing the point I think.

Honourable mention goes to the OECD and the work of Warwick, who had several interesting papers on industrial policy in the mid 2010s. Here’s a nice quote from this paper:

“A broad definition is ‘any type of intervention or government policy that attempts to improve the business environment or to alter the structure of economic activity towards sectors, technologies or tasks that are expected to offer better prospects for economic growth or social welfare than would occur in the absence of such interventions.”

There’s a lot there, but I think one word is critical – any. This begins to open the door to myriad possibilities. What does any mean? Social policies? Labour policies? Health policies? Education policies? Environmental policies? This goes further than the Carnegie quote by not wishing away the complexities of industrial policy.

But from the papers I’ve assembled over the years, these series of excerpts are the winners for me.

• In other studies, we ourselves define industrial policies as broadly as ‘any programs of government that relate directly to the economic activity of one or more of a nation’s regions, industries, firms, or plants.’

• However broadly or narrowly the definitional net is cast, many subclassifications of industrial policy are possible. For example, they can be classified as ‘interventionist’ or ‘noninterventionist.’ Noninterventionist policies can be divided into general macroeconomic policies and general structural policies (such as free trade and competition policy). Interventionist policies, to which most attention has been directed, particularly by those who want to develop an industrial strategy, can be divided into general industrial policies, industry-specific policies, regional policies, and firm-specific policies; they can also be divided into those that promote growth, those that protect against change or decline, and those that assist adjustment (the reallocation of resources away from declining industries). Policies can also be divided in terms of the policy instruments employed: regulations, subsidies, tariff protection, nontariff barriers, procurement policy, government ownership, tax incentives, and so on.

• Almost every public policy affecting business – particularly, those policies intended to promote, defend, or assist specific industries – falls within the ambit ’industrial policy,’ in the end everyone defines the term to suit his or her own purposes.

• (Industrial policy is) broadly as a set of policies affecting industrial structure. Such policies may operate at the level of the whole economy, of an industry, or of firms. They may be aimed at choosing and backing winners, at saving losers or helping them to adjust, or at providing an appropriate environment for economic forces to determine the outcome.

“Industrial Policy In Ontario,” Richard M. Bird, Ontario Economic Council, 1985.

Perhaps it’s a bit unfair to cite so much from one paper compared to the others. That being said, Bird was shrewd enough to explore the definition more thoroughly than most. Key ideas he introduces include:

• The existence of subclassifications, in this case, noninterventionist vs. interventionist industrial policies;
• The idea that industrial policy can be broad, involving almost any public policy; and
• The scope of analysis/intervention can be to the firm, the industry, or the entire economy.

With Bird’s highly robust and nuanced definition in mind, I can start to map out a definition for this blog that can be applied to evaluate industrial policies. More to come on that!

Recent developments in the US under the Biden Administration, as well the recognition of economic gaps in the wake of Covid-19 across the developed world, have slowly returned the previously exiled (and reviled!) term of “industrial policy” back into the broader public discourse. Governments and parties on both the left and right are increasingly implicitly or explicitly calling for a more active role of “The State” in economic development to address economic challenges. This was most clearly seen in efforts to increase Covid-19 vaccine production capacity in many developed countries.

But the actions of the Biden Administration have perhaps been the most demonstrable example that a change is at hand. Recent legislation has promised to restore the US’ industrial capacity in semiconductors. Legislation related to electric vehicles demonstrates that a laissez-faire approach to the auto sector is no longer acceptable when confronting the twin issues of climate change and China’s industrial might in this industry.

Even conservative organizations have called for industrial policy in the face of myriad challenges. In the US, organizations like American Compass, led by one- time Mitt Romney domestic policy director Oren Cass, have written several articles and organized events on industrial policy. Under both the May and Johnson governments in the UK, clumsy attempts (despite the influence of luminaries like Marianna Mazzucato) have been made at reversing the decades-long over-financialization of the UK economy through a diversification-driven industrial policy platform. In Canada, a prominent think-tank (The Brookfield Institute) released a paper calling for “An Inclusive Industrial Policy for Canada.”

But despite this growing attention, it must be said that industrial policy never went away. What’s the proof?

• Authors, most notably Dani Rodrik and Ha-Joon Chang, have written extensively about industrial policy. There are many other scholars and authors that have too, but perhaps not to the same notoriety as Rodrik and Chang.
• Neoclassical/neoliberal organizations like the Organisation for Economic Co-operation and Development (OECD) have written about industrial policy off and on for years. Normally, their publications correlated with recessions (think 2008 Global Financial Crisis and the initial phases of the Covid recession in 2020).
• Perhaps most critical, the success of the Chinese economy, especially after its succession to the World Trade Organization, demonstrated that the developmental state model/industrial policy approach was worthy of study. Any investigation of the Chinese growth model indirectly is a study of industrial policy.

Last, but not least, one can argue that industrial policy never really went away, but only had a toxic brand. As will be explored in a future post, if industrial policy is defined as horizontal or vertical policy interventions by governments to affect the industrial composition and outcomes of an economy, all governments engage in industrial policy! Even the most non-interventionist, laissez-faire government claiming to use a hands-off approach to economic growth is probably using a few industrial policy instruments like tax or regulatory reform. While some may find this argument a cop-out, I think it reasonable. The question is not “industrial policy: yes/no?”. A better question is “what kind of industrial policy does this jurisdiction want?”

That is what this blog will hope to explore!