Industrial policy vs. corporate welfare

For those particularly on the political right or in the mainstream of economic thought, industrial policy inevitably equals direct funding to businesses. As discussed in previous posts, this is a vast oversimplification. Direct subsidies to businesses, particularly in the form of a grant is but one tool in the industrial policy toolkit. (Those on the political right often clamour for tax reductions without acknowledging that this has a comparable effect on government financial capacity. A grant reduces the government’s cash on hand or future cash reserves. Pretty sure a tax credit does the same thing, but I’m getting off track here.)

Should advocates of industrial policy instinctively call for direct grants to business? As we are seeing in countries like the U.S., Canada, and others in the hunt for EV vehicle/battery production? I’m not so sure about that.

Perhaps we should focus on the ends, rather than the means. What is the point of industrial policy? To create an industrial mix that achieves public policy objectives (e.g., full employment, rising real incomes, self-sufficiency in critical goods like food/medicines/military products for self-defence, etc.). Are direct subsidies the only way to achieve such goals? Absolutely not. If anything, direct subsidies should only be used as the last resort. So what can be done instead? Well, off the top of my head, things like:

  • Regulations – for instance, certain types of products must be produced locally. Typically, this is a result of national defence requirements, but not always.
  • Tariffs – while this has fallen out of favour due to the GATT/WTO trade regimes, this approach was used by people like Alexander Hamilton to develop the U.S.’ industrial capacity.
  • Privileged/Preferential Access to Capital – in the modern era, this is seen in Chinese government support for various firms. But even for advanced economies, there is often a development bank/export bank lurking somewhere.
  • Taxation policy – using Pigouvian subsidies in the tax system to reward things we like (e.g., production of goods that are considered strategic/important) while discouraging of goods seen as harmful (like tobacco).
  • Strategic procurement – pretty self-explanatory I think.

The above list is not exhaustive, but hopefully the point has been made. Direct subsidies as seen in the Inflation Reduction Act are but one tool that can be used. So if they are a tool, when should they be used. Well:

  • Firm size should be a consideration. For instance, small firms have more difficulty accessing bank financing due to information asymmetries. Thus, there is a market failure that can be addressed through a grant, though other policies like loan guarantees could also be considered.
  • Risk of the investment should be a factor. For unproven technologies that could have large and positive externalities for the public (e.g., general purpose technologies like semiconductors in the 1960s), there is a rationale for a grant.
  • Maintaining production capacity for “insurance purposes.” In the case of the pandemic, it was exposed in the advanced world that surplus capacity had been eradicated because of the mythology of “just in time” and the “free movement of goods.” But when your neighbour is low on sugar, they’re not going to lend you any. Replace sugar with medical equipment, and neighbour with every country on earth, and that’s sort of what happened during the pandemic.

So given the above framework laid out above, where do subsidies for EV and EV batteries fall? Well, there is a risk component, but not really. Governments could eliminate the risk through regulations to increase the demand for these vehicles. What about capital flight? Well, this is not the fault of industrial policy per se, but of global trade rules that supported the neoliberal variant of industrial policy. So not only do governments have to de-risk the technologies through R&D support and VC funding, or even make the market for EVs through regulation, but they must also pay to build the damn cars too.

I think governments have done enough for the auto sector. While this sound like a right-wing smear, large auto companies do not need money to build factories for cars and batteries. They just want the money because a free trade system allows for a “race to the bottom” on subsidies that steals from government coffers to create private profits. This is not industrial policy as envisioned earlier in this piece. This is socialism for the rich. I’m all for socialism, but not for the rich!

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