You read the title, and you say "here he goes again." OK, I admit it. I have been a bit obsessed with industrial policy lately. But there is a reason. I have been writing another paper on the subject, as an input to the work of the World Bank's Commission on Growth and Development. The Commission is headed by Michael Spence (who has turned his attention to growth and development recently), and its secretary is the very able and sensible Roberto Zagha.
Here, as a teaser, is an excerpt from the introduction:
Consider a set of policy interventions targeted on a loosely-defined set of market imperfections that are rarely observed directly, implemented by bureaucrats who have little capacity to identify where the imperfections are or how large they may be, and overseen by politicians who are prone to corruption and rent-seeking by powerful groups and lobbies. What would your policy recommendations be?
You might be excused for thinking that I am referring to industrial policy and if you react by saying “these are all reasons why governments should stay away from industrial policy.” But in fact what I have in mind are some of the traditional, long-standing areas of government intervention such as education, health, social insurance, and macroeconomic stabilization. All of these policy areas share the features described in the previous paragraph. Yet, curiously in light of the skepticism that attaches to industrial policy, almost no-one questions whether they properly belong in the government’s arsenal.
Consider the parallels with industrial policy. Interventions in each one of the conventional areas I just listed are justified by market failures that are widely felt to exist, although rarely documented with any precision. So education and health interventions are motivated by human capital externalities, social insurance by asymmetric information, and stabilization policy by aggregate-demand (Keynesian) externalities (to list just some of the more prominent market failures). Systematic empirical evidence on these market imperfections is sketchy, to say the least, which is why there continue to be vibrant academic debates on their role and magnitude. Even the least controversial among them, positive externalities associated with schooling, have proved difficult to pin down convincingly.
Moreover, in each one of these areas bureaucrats have wide latitude in implementing policies, while remaining in the dark about the nature of the root problems. Spending ministries make budget allocations with little capacity to evaluate the impact of their decisions. Bureaucratic routine rather than economic logic determine much of the behavior on the ground. And powerful groups and lobbies typically exert significant influence on the policy process. In education, teachers’ unions have a loud voice on what should be done (or cannot be done). In health policy, it is often insurance firms and the medical doctors’ association who get their say. Tax and spend decisions are similarly subject to influence from organized lobbies. All these shortcomings notwithstanding, the debates in these policy areas are rarely ever about whether the government should be involved; they are about how the government should go
about running its policies. It’s not about whether, but about how.
Why can't industrial policy be the same? It's beyond me.
The paper describes the market failures that call for industrial policy (they are in fact central to the way economists think about development), evaluates available empirical evidence (inconclusive, by the very nature of the methodologies employed), discusses existing industrial policies in a few non-Asian countries (there is a lot more of it than you might think), and proposes some "design features" to reduce the agency costs opponents are concerned about (it can be done).
In light of the recent exchanges in around this blog, let me emphasize that last bit in particular. A key point of the paper is that the shortcomings of governments should not be taken as a given. Just as economists think about how to improve market institutions, they can devote their talent to improving the institutions of government. The informational and rent-seeking costs of government intervention can be ameliorated through appropriate institutional design.