The misleading empirics of industrial policy

Commenting on my previous post, Kenji asks: "What is your take on empirical studies that show that industrial policies often have a neutral or often negative impact on total factor productivity?" There is indeed a large number of cross-industry regression analyses that yield the following result: the higher the level of government support for an industry (subsidies, trade protection and so on), the worst the productivity performance of the industry. Sounds like pretty damning evidence, right?

Wrong. Actually, these studies say nothing at all about the effectiveness or desirability of industrial policy. And here is why.

Suppose you are a government that has some second-best policy instrument at your disposal (say tariffs) to correct a market failure which an industry is subject to. You recognize that the policy has some costs (rent-seeking, and so on), and you use your policies accordingly to maximize national welfare. Different industries are subject to varying amounts of market failure. Now in this kind of setting, what would you expect the relationship across industries between the tariffs and economic performance to be? The somewhat surprising result is that actually we would expect to find a negative relationship between the policy intervention and performance. Why? Because a welfare-maximizing government would respond to a larger market failure by increasing its intervention, but not so much as to fully neutralize the market failure's adverse effect on performance. The correlation we would find in the data between performance and intervention would be negative. So far from taking the existing empirical results as refuting the idea that industrial policy works, you might as well take these as confirmation that it does! For more details on this argument, see here.

By the way, this is a nice illustration of how neoclassical reasoning (maximization, equilibrium, comparative statics) is often the best antidote to silly orthodox thinking.

Comments

[Daniel from Bolivia]

Dani:
It seems that you are talking about developed countries.
In the case of Bolivia, or a developing country in general, it seems that evidence support the fact that industrial policy or microecnomics public policies are needed to improve a poor industry basis, where agriculture is the main "cluster".

[Kenji]

Thanks for the follow-up! I wish I had you as my economics professor...

[paine]

DR
Ii'm taken
by your ending squib:

"By the way, this is a nice illustration of how neoclassical reasoning (maximization, equilibrium, comparative statics) is often the best antidote to silly orthodox thinking"
recall your ice clear rendition of the trade gain postulates

why not try giving
the ortho paradigm
a similar whurl
i noticed in all the talk
no attempt to define
it

[Michael Sullivan]

This is a great observation.

It does cause me to eagerly consider a follow-up question: What kind empirical evidence would you accept that industrial policy does not work either in general, or in some specific industry?

And of course, the inverse question should be asked of those who take the opposite side of the argument: What evidence would they accept that industrial policy *does* work, either in general, or in a particular industry.

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Professor. let me say you that your comments are very intelligent, and pertinent at academic level. Usually private and public spheres fall in this type of errors, slanting the results toward that want politically to interpret. I congratulate your work, and from now I will be your continuous reader. From Ecuador a warmest regard

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