The Return of Industrial Policy
September 13, 2023
By Brock Smith
In terms of raw spending, the Inflation Reduction Act (IRA) is the biggest piece of
climate legislation ever passed in any country. Ageconmt’s Nick Haggerty recently
gave a brief overview of the climate spending provisions. The bill amounts to a firehose of tax credits
and other subsidies for all kinds of carbon emission-reducing technologies. Similarly,
the CHIPS act passed shortly before the IRA directs $250 billion in federal spending
towards semiconductor research and manufacturing, with the aim of keeping pace with
China in the semiconductor technology race.
These two bills signify that the US is embracing “industrial policy”, an idea that
has generally been out of favor among economists and Western governments in recent
decades. Industrial policy, broadly defined, refers to a set of government policies
designed to boost domestic production in certain economic sectors. These policies
can include sector-specific tax breaks or other government subsidies, favorable trade
rules, or simply direct government production (e.g. highways).
The U.S. has occasionally embraced industrial policy, but typically only in response
to some external threat. The starkest example is the government-led World War 2 mobilization.
After that, competition with the Soviet Union compelled large government outlays towards
the space race and other military technologies–this is what eventually led to the
development of the internet and GPS technology.
But industrial policy is most often discussed in the context of developing countries.
Japan and the other “Asian Tigers” (Hong Kong, Taiwan, Singapore, South Korea) used
extensive industrial policy to become high-income manufacturing powerhouses. But other
countries, notably in Latin America, were much less successful. Most Western governments
and economists in recent decades have promoted an alternative paradigm called “the
Washington Consensus”, which is a set of recommendations regarding macroeconomic policy
for developing countries (sometimes enforced by the IMF as a condition for financial
assistance). The Washington consensus recommends low government spending and borrowing,
low tax rates, privatization of state enterprises, and deregulation, among other things.
Broadly speaking, it amounts to “where feasible, get government out of the way and
let the market rip.”
Economists tend to disfavor industrial policy because they argue that governments
should not be “choosing the winners”. Even if a certain industry favored by policy
successfully grows, it may have come at the expense of other sectors that would have
performed even better. Capital seeks the highest return, and industrial policy may
just get in the way. Further, politically powerful sectors can lobby the government
for policies that favor them, and this again may come at the expense of more beneficial
sectors.
On the other hand, one of the most common arguments for industrial policy is the “infant
industry argument”, in which new industries should be protected from global competition
until they mature. Another argument is that some industries confer benefits to society
that are not captured strictly by market values (or “externalities”). Both of these
arguments can be applied to the IRA: China–using extensive industrial policy of their
own–has raced ahead of the US in green technologies like solar panels, which promises
to be a major growth sector for many years to come. And the subsidies for green tech
will have the positive externality of reducing carbon emissions and mitigating the
impact of climate change. Another argument in favor of industrial policy is that some
products are so important that they need to be produced domestically to ensure a steady
supply. This is one of the impetuses for the CHIPS act, which aims to bring semiconductor
manufacturing back to the United States so that it is less vulnerable to future supply
chain disturbances.
Whatever the theoretical merits, the US’s recent legislative activity implies that,
for now, industrial policy is back in a big way. Whether it represents a structural
shift in economic policy or a temporary blip remains to be seen.
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