Richard B. McKenzie
The Concise Encyclopedia of Economics

Industrial Policy

by Richard B. McKenzie
About the Author
National industrial policy is a rubric for a broad range of proposed economic reforms that emerged as a unified political program in the early eighties. Had they been passed, these reforms would have given government officials additional authority, as well as the necessary fiscal and regulatory powers, to directly alter the country's industrial structure. Proponents of national industrial policies (NIP) across the globe have typically been harsh critics of unfettered markets and of past limited efforts of government to create economic growth simply with macroeconomic (fiscal and monetary) policies.

In the United States NIP became a major bone of contention in the 1984 presidential campaign. Democratic presidential contenders Gary Hart and Ernest Hollings and the eventual nominee, Walter Mondale, were vocal NIP advocates. The Republican incumbent and nominee, Ronald Reagan, was a staunch NIP opponent. Mondale argued that the economic policies of the country were "destroying industry—not building it," and that federal aid should be directed to "those communities and regions hit hardest by economic change."

NIP proponents believed, and some still believe, that many of the country's industrial markets had failed, causing the entire economy to come apart at its industrial seams. Harvard's Robert Reich, a leading exponent of industrial policies in the early eighties, claimed, in The Next American Frontier, that the U.S. economy had been "unraveling" since the sixties. He found "chronic disarray" in the political sphere, which he linked to the "growing unemployment, mounting business failures, and falling productivity" in the economy's industrial sector.

More specifically, NIP proponents claimed the following:

  • The nation is in long-term economic decline, with little hope of a turnaround without greater government involvement in the restructuring of the economy.
  • The country is "deindustrializing," or losing its core industrial base to plant closings and "capital flight." In The Deindustrialization of America economists Barry Bluestone and Bennett Harrison argued that the ongoing process of deindustrialization amounted to a "wide-spread, systematic disinvestment in the nation's productive capacity." Without its "core" industries—steel, textiles, rubber, shoes, and automobiles—the national economy will lose its stature in the world, and workers will lose their better-paying employment opportunities.
  • Major segments of the U.S. economy are uncompetitive in the new global economic order. Many U.S. firms are gradually being destroyed by their own misguided internal policies, by their pursuit of short-term profits, and by foreign competitors that are more successful primarily because of the national industrial policies adopted by their governments. The postwar economic success of Japan was extensively credited to industrial policies orchestrated by its Ministry of International Trade and Industry (MITI). Economist Lester Thurow of MIT, in The Zero-Sum Society, worried that if left alone, "our economy and our institutions will not provide jobs for everyone who wants to work," and that "we have a moral responsibility to guarantee full employment."

While acknowledging that his proposed industrial policies would create "a socialized sector of the economy," Thurow maintained that "major investment decisions have become too important to be left to the private market alone.... Japan Inc. needs to be met with U.S.A. Inc." Reich contended that Japan and several European countries were growing relative to the United States because "these countries are organized for economic adaptation.... America is not."

NIP proponents generally believe that government should be directly involved in establishing national industrial goals and in assuring that the goals are achieved. Some early proponents (John Kenneth Galbraith, for example) would have had government extensively plan major sectors of the economy, dubbed the "new industrial state," if not the entire national economy. Galbraith would have had the federal government decide the industrial structure, redistribute resources and output, and reallocate income from one region of the country to another and from one income class to another. More recent NIP proponents (including Felix Rohatyn, a New York investment banker; Lester Thurow; and Robert Reich) have been more moderate. They presented less ambitious policy programs but still wanted the government to determine which industries were most likely to be competitive in the future global economy and to contribute to improved economic opportunities for workers. Government would then determine if and how the identified industries should be aided. Specifically, most modern NIP advocates pressed for some of the following:

  • National and regional economic "development banks," similar to Herbert Hoover's Reconstruction Finance Corporation, which would use subsidies and federal loan guarantees to slow the contraction of declining industries and to speed the development of emerging industries.
  • "Tripartite councils" at the national, regional, and firm levels, which would be composed of representatives from management, labor, and government and would seek consensus on how capital investment should be allocated.
  • "Industrial (or economic) democracy," in which representatives of workers and the communities surrounding plants or offices would be given a greater say in the investment, disinvestment, and reinvestment decisions of firms.

NIP supporters also advocated federal and state expenditures for basic education and worker training and retraining that would increase the country's competitiveness, plant-closing restrictions that would slow the outflow of capital, and federal spending on day-care facilities that would enable more parents to participate in the work force. They also advocated raising the minimum wage and tying it to some average industrial wage, using tax law to discourage mergers and acquisitions, which they called "paper entrepreneurship," and using government to spread the existing capital base across states and regions.

Finally, NIP proponents generally supported protectionism, especially in the early and mideighties. They wanted tariffs, quotas, and "voluntary export restraints" for "key" industries (identified as such by the tripartite councils, for example) with the goal of "managing trade" to achieve broad industrial goals and to bring down the then-rising trade deficit.

One industrial policy advocate crystallized a common position that made the movement appealing to many industry executives: Without trade barriers, rich countries are bound to suck in cheap imports from low-wage countries, destroying the domestic industries that used to make those products. There will never be enough "high-tech" jobs to employ those who lose more traditional jobs. Therefore, unrestricted trade would eventually destroy the economies of all high-wage, developed countries.

Although the industrial policy movement created a major policy stir in the early and mideighties, it faded in the late eighties as quickly as it had emerged. Its fall from political and media grace can probably be attributed to six sources.

First, one of its leading exponents, Walter Mondale, suffered an overwhelming defeat in the 1984 presidential election, suggesting that his industrial policy agenda was not striking the expected chord with the electorate.

Second, the Reagan administration, while often conceding on protectionist proposals, maintained strong opposition to any coherent industrial policy programs, including national economic development banks, tripartite councils, and economic democracies.

Third the growing federal deficits probably choked the ability of NIP supporters in Congress to organize the necessary majority for any expensive new government programs.

Fourth, the pessimistic claims and projections for the future made by NIP proponents did not square with the economic facts brought to light in various forums. Brookings Institution economist Robert Crandall, in the Washington Post, pointed out that French and German readers of Reich's book (and those of other NIP supporters) would be "amazed to read of their government's success in industrial policy. Since 1975, industrial production has grown even more slowly in France and West Germany than in the United States." He continued:

The [U.S.] industrial sector did not decline markedly from the mid-1960s to 1980. In fact, basic industry accounted for roughly 22 percent of our GNP in 1980, precisely the same share as in 1947. Our output per person remains above that of all but a few countries, such as Sweden and Switzerland (which have not exactly been refuges for the world's dispossessed over the 20th century). Reich's contrary conclusions are drawn from a period ending in 1979. Were he to extend his calculations to 1981, he would find that the United States has outperformed every major industrial country in the world except Japan since 1975.

Moreover, several strategically placed researchers (including Philip Trezise at the Brookings Institution, David R. Henderson on the staff of the Reagan Administration's Council of Economic Advisers, and Katsuro Sakoh at the Heritage Foundation) reached conclusions similar to Crandall's. Regarding the economic success of his home country, Japan, Sakoh stressed, in a Heritage Foundation report, "There is no evidence that manufacturing industries in general, and any particular manufacturing sector, have been targeted [as of 1983] by the JDB [Japanese Development Bank]." Much of Japan's public funds, which in total were judged to be "negligible," were also wasted supporting "losers." Also, MITI's efforts in the sixties to discourage Honda from going into automobile production were widely cited as a "failure" of whatever Japanese industrial policy did exist.

Throughout the eighties the U.S. economy continued an upward ride on one of its longest peacetime recoveries. Rather than falling, industrial production continued to rise, peaking in 1990 (before the advent of the 1990-91 recession) at 32 percent above its 1980 level. Rather than continuing its highly advertised long-term decline relative to the rest of the world, U.S. output was the same share of world output in the mid-eighties as in the midseventies, and it rose slightly in the late eighties. Although the number of manufacturing jobs did fall during the eighties, manufacturing output, measured in real dollars, rose. The reason was a surge in manufacturing productivity induced in part by international competition.

Instead of wantonly destroying jobs in the eighties, the U.S. economy was, on balance, rapidly creating them. Total U.S. employment rose by about 19 million (18 percent) from 1980 to 1990. While the average real money wage (not including fringe benefits) of production workers edged downward, as did their share of the country's labor force, the average hourly payment (with both money wages and benefits included) of all American workers rose, albeit at a slower pace than prior to the early seventies.

Fifth, while Republican opposition to the NIP movement remained solid, Democratic support was badly split. Democratic economists could not support the protectionist aspects of industrial policy. They understood, as most NIP advocates did not, that free trade does not destroy jobs and that protectionism almost always makes a country worse off by hurting consumers more than it helps producers. Economists found, for example, that trade restrictions on textile imports, by increasing retail prices of clothing, destroyed far more domestic retail jobs than they saved in the domestic textile industry.

Also, Democratic economists feared that development banks and tripartite councils would give declining industries and unions undue political power. This newfound power, critics reasoned, might be exploited to the detriment of emerging industries and the competitiveness of the entire country. They also pointed out that the subsidies required to slow the decline of contracting industries would mean higher taxes, which would discourage the emergence of so-called "sunrise" industries.

Probably the most outspoken Democratic opponent of industrial policy was Charles Schultze, an economist at Brookings who was chairman of President Carter's Council of Economic Advisers. Schultze, in the Brookings Review, undercut the political and intellectual case for industrial policy with these salient points:

The United States does have some old-line heavy industries with deep-seated structural problems—especially the steel and automobile industries—but they are not typical of American industry generally. There is no evidence that in periods of reasonably normal prosperity, American labor and capital are incapable of making the gradual transitions that are always required in a dynamic economy, as demand and output shift from older industries to newer ones at the forefront of technological advances.

One does not have to be a cynic to forecast that the surest way to multiply unwarranted subsidies and protectionist measures is to legitimize their existence under the rubric of industrial policy. The likely outcome of an industrial policy that encompassed some elements of both "protecting the losers" and "picking the winners" is that the losers would back the subsidies for the winners in return for the latter's support on issues of trade protection.

Sixth, policy forces around the globe in the eighties were running counter to the fondest policy dreams of the NIP proponents. Rather than expanding their control over their economy, many major governments began cutting taxes, capping the growth of their expenditures, deregulating and denationalizing industries, and privatizing many government services. Yet these policies, contrary to the expectations of the NIP proponents, did not cause economic calamity.

Industrial policy proposals continued to attract a measure of political support into the early nineties. The proposals were redirected from the national to the state level and from direct support of industries to direct support for workers and the country's infrastructure. Still, the support remained subdued. By 1991 key industrial policy proponents, most notably Robert Reich, had reversed themselves or had significantly altered their positions. They began to reason that physical and financial capital had become far too mobile across national boundaries to make government subsidies pay. Former NIP enthusiasts, especially Reich, maintained that workers were the real wealth of any country. Because workers were relatively immobile and could, therefore, be counted on to repay their subsidies with future tax payments, workers—not firms—should be more extensively subsidized, through government training and retraining programs intended to develop and maintain their human capital.

Even the revised NIP agenda faces some major problems. One is that high federal and state deficits mean that few funds are available for NIP. NIP proponents advocate raising the funds by taxing the "rich." But as public finance economists know well, the only way to increase federal revenues substantially is to tax the nonrich. The "rich" are simply too few and too able to increase deductions and to reduce work effort when marginal tax rates rise for an increased tax on them to increase revenues very much. Moreover, the highly paid workers (a large component of the "rich") are almost as mobile as physical capital. NIP proposals can encourage human-capital flight.

About the Author

Richard B. McKenzie is the Walter B. Gerken Professor of Enterprise and Society in the Graduate School of Management at the University of California at Irvine.

Further Reading

Bluestone, Barry, and Bennett Harrison. The Deindustrialization of America: Plant Closings, Community Abandonment, and the Dismantling of Basic Industry. 1982.

Democratic Caucus, U.S. House of Representatives. Rebuilding the Road to Opportunity: A Democratic Direction for the 1980s. September 1982.

McKenzie, Richard B. Competing Visions: The Political Conflict over America's Economic Future. 1985.

Reich, Robert. The Next American Frontier. 1983.

Schultze, Charles. "Industrial Policy: A Dissent." Brookings Review (October 1983): 3-12.

Trezise, Philip. "Industrial Policy Is Not the Major Reason for Japan's Success." Brookings Review (Spring 1983): 13-18.

Industrial Policy: Democratic Economists Speak Out

One reason that industrial policy was never implemented in the United States was that Democratic economists opposed it. They did so, in part, on the grounds that governments cannot know which industries will be winners. In the Brookings Review, Brookings economist Charles Schultze, chairman of the Council of Economic Advisers under Jimmy Carter, wrote:

The first problem for the government in carrying out an industrial policy is that we actually know precious little about identifying, before the fact, a "winning" industrial structure. There does not exist a set of economic criteria that determine what gives different countries preeminence in particular lines of business. Nor is it at all clear what the substantive criteria would be for deciding which older industries to protect or restructure.

Schultze's fellow economist Alfred Kahn, who was President Carter's chief inflation fighter, stated: "Cast a skeptical eye on glib references to the alleged success of government interventions in other countries in picking and supporting industrial winners."

And MIT's Paul Samuelson testifying, before Congress, said of industrial policy: "It's not good macroeconomics. And I don't think it's defensible social philosophy."

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