Michael Spence, who shared the 2001 Nobel Prize in economics, is an emeritus professor of economics at Stanford University’s Graduate School of Business. He recently wrote an op/ed titled “In defense of industrial policy.” It is gated at Project Syndicate but appears ungated in the Jordan Times.
His case is, at best, flabby. It lacks any empirical evidence and takes as given, without argument or evidence, the idea that many government interventions have benefits that exceed costs.
A few highlights:
The objective of industrial policies is to alter market outcomes in ways that align them better with a country’s broader economic and social objectives. Free-market purists may bristle, but in the real world many relatively uncontroversial and even widely supported, government interventions shape market outcomes.
The first 10 words are correct. But what does he mean by “a country’s broader economic and social objectives?” Does he mean the economic objectives of a president and a Congress? I think so. But why should we give weight to their preferences? Is it the old “we voted for them” argument? But what about the fact that even the majority of registered voters, let alone the majority of U.S. adults, didn’t vote for them? Moreover, given everything we know about the incentives of politicians and about who rises to the top, aren’t their objectives likely to be fairly narrow rather than broad?
He says that “Free-market purists may bristle.” That’s probably true. But wouldn’t even many clear-thinking people who aren’t free-market purists bristle also at the ease with which Spence would have government dictate to the rest of us? By focusing on free-market purists, though, a group that he must know is relatively tiny, he manages to avoid actually making an argument. He’s saying, in effect, we can dismiss them because they’re purists.
He then writes:
For example, public-sector investment in infrastructure, education and the economy’s science and technology base is considered an essential complement to private investment, mitigating risks, increasing returns and bolstering overall economic performance. Other widely accepted interventions that alter market outcomes include antitrust or competition policy, measures to overcome information gaps and asymmetries and regulation to address negative externalities, protect user data and guarantee the safety of everything from airplanes to food.
Let’s consider this paragraph bit by bit. Note Spence’s use of the passive voice in his first sentence. Considered by whom? He doesn’t tell us. Probably considered by Spence and certainly by many others. But on what basis do they reach these conclusions? Blank out. Now consider his second sentence. It’s true that the interventions he mentions are widely accepted. But should they be? He seems to take as given that because they’re widely accepted, they’re good ideas. And do we get safer airplanes because government regulates? Maybe. But I can tell you how we get more dangerous airplanes in general aviation than we would likely get with minimal or no regulation. The FAA makes it so costly for a small airplane producer to get permission to sell innovative products, that many possible products don’t exist. So airplane owners hang on to older airplanes for 40 or 50 years. The odds are, given that safety is a normal good and that real income and wealth have increased a lot in the last 50 years, that without costly regulation, many new safer airplanes would exist and send at least a few of the older less-safe airplanes to the garbage dump. But Spence doesn’t consider this possibility.
Spence then writes:
But these are responses to known market failures. Industrial policies, at least the most divisive ones, go a step further, reshaping the supply side of the economy in pursuit of objectives other than efficiency in the allocation of resources.
His first sentence is simply an assertion. He gives no basis for it. His second sentence, though, is correct.
Aware that he must deal with the issue of the government picking winners and losers, he writes:
The second component, however, has proved divisive. Critics point out that selective public investment in any industry’s productive capacity amounts to picking winners and losers. In their view, governments are not well-equipped to take on this task, not least because vested interests can capture the decision-making process.
Though this argument in favor of relying on market outcomes should not be dismissed out of hand, it should be met with some scepticism, not least because it is often rooted in an almost religious commitment to unfettered competition. In fact, industrial policy can be essential to a country’s long-term economic survival, as in the case of defence, particularly in times of war.
The first paragraph of the two above is promising. Spence shows that he’s aware of the special interests that could distort the process and lead to bad results. But the second paragraph undercuts that. The argument, he says, “is often rooted in an almost religious commitment to unfettered competition.” For some people who make that argument, that’s probably true. But whether it’s rooted in such a commitment isn’t relevant. The questions is, “Is the argument correct?” But by bringing in the idea that some of the people who disagree with him might be “religious” about their disagreement, he cleverly avoids actually dealing with the argument.
Spence then writes:
The real question is not whether industrial policy is worth pursuing, but how to do it well. Government capacity is decisive: to act effectively as an investor and major buyer of products and services, the government needs people with talent and experience, receiving compensation to match, and well-designed institutions. Moreover, goals should be precise, limited and clear, and guardrails must be erected to protect against private-sector capture. Industrial policy is not corporate welfare.
Isn’t that only one of the real questions? Isn’t another question whether industrial policy is worth pursuing? Is this question irrelevant? Spence seems to think so.
Spence asserts that the Defense Advanced Research Projects Agency (DARPA) and the government support of the COVID-19 vaccine are examples of successful industrial policies. That might be true, but he doesn’t give evidence to support his claim.
Spence admits that there are industrial policy failures but points out that venture capitalists fail too. He writes:
No one expects every investment made by a venture-capital fund to be a home run. Governments should be afforded the same leeway. A decent track record is good enough to make industrial policy pay off for taxpayers.
His first sentence is absolutely correct. But the difference between venture capitalists and governments is that venture capitalists are betting their own money while governments are betting our money. That’s a big difference. The very essence of economics is its focus on incentives. The incentives for venture capitalists and government officials are quite different. If the venture capitalists succeed, they might make a lot of money; if they fail, they lose their own money. If government officials succeed, they might get a nice promotion and $10,000 or $20,000 more annually; if they fail, they might not even get demoted.
I would have thought that the difference in incentives would be one of the first concerns that would arise in the mind of an accomplished economist. But maybe Spence would say that that’s because I’m religious.
Postscript: Here is the biography of Michael Spence that I wrote in The Concise Encyclopedia of Economics.
READER COMMENTS
Jon Murphy
May 12 2023 at 8:19am
Some other issues I’d raise:
He talks about social objectives, but why wouldn’t the results of the market process be such social objectives? Most Principles textbooks treat it so (even when taking into account externalities). That he blows past a key aspect of Principles of Economics is concerning.
Not to mention that Arrow, among others, pointed out there is no such thing as a social objective.
And speaking of market failures, market failures are highly subjective. Industrial planning grossly fails to adjust for them, usually over adjusting.
I’m also not sure it’s a great idea to hold up covid vaccines as an example of a success given what a cluster they were. First, the vaccines were developed pre subsidies but sat in regulatory malaise for 6 months. When they were finally given EUA, the rollout was highly regulated and politicized and had nothing to do with who was at most risk or achieving social objectives. Coupled with the various mandates that followed which led to a reduction in supply of health care, it made the failure even worse.
If covid is your best example, then the case for policy is even worse.
Jose Pablo
May 12 2023 at 3:32pm
Not to mention that Arrow, among others, pointed out there is no such thing as a social objective
… and that Hayek already warned us that “social objectives” (in particular “social justice”) would be used to impose, “whoever hold power” agenda on the rest of us. Based on a arbitrary concept that could not be measure and that makes impossible render power accountable for their achievements (or the lack of them)
https://venezuelanalysis.com/news/10731 …. just wondering how this “social objective promoting industrial policy ended up” …
… although the reason surely is that it wasn’t well designed. If it had been designed by Spence …
Chris Oldman
May 12 2023 at 8:34am
Regarding the argument that government should set economic policy, he’s basically arguing that 50-55% of people (who change every four years) making economic decisions for the other 45-50% is superior to 100% of people making their own economic decisions.
Industrial policy proponents need to contend with the idea that in a free economy, every person is voting on their preferences on a daily basis, with their own money. A free market economy, in many ways, is a purer form of democracy than a formal government because it better allows for a panoply of preferences, that a binary majority/minority system does not.
Jose Pablo
May 12 2023 at 5:27pm
he’s basically arguing that 50-55% of people (who change every four years) making economic decisions for the other 45-50%
It is much worse than that. What is really happening is that a group of very few people (some, but not all, of which have been “elected” following an arbitrary set of rules that defines a very particular meaning of “representation”), enact some new regulation that restrict the freedom to trade of 100% of the agents.
That this way of proceeding can produce an “optimal” has to be truly a miracle … well, maybe if Spence is among the “non-elected few” designing the restrictions, achieving this ill defined optimal would not be a “miracle” but an “unavoidable destiny”.
Jon Murphy
May 12 2023 at 11:01am
One other point to make viz-a-viz COVID:
I think Spence is making a huge mistake by looking at COVID vaccines in a vacuum rather than part of the entire industrial planning operation that was happening during COVID. Yes, vaccine development occured fairly well, but the system as a whole was a horrific failure and a lot of empirical evidence indicates that the government response made COVID worse. I mean, the scheme failed so badly that the architechs of it are now desprately trying to wash their hands of it.
One cannot look at a single instance of policy and then make grand proclimations about the whole. We have to look at the whole.
Knut P. Heen
May 12 2023 at 11:02am
The Chinese refused to trade with Norway after the Nobel Peace Prize was given to a Chinese dissident. Relying on buying cheap stuff from China may reduce our right to free speech.
Charlemagne did not want his people to trade with non-Christians. The Vikings had to accept baptism to trade. Probably one of the reason they raided France instead.
Trading with difficult people often comes at non-monetary costs (like giving up your right to free speech and free religion). Liberty preserving industrial policies may be acceptable.
Jon Murphy
May 12 2023 at 11:19am
Can you point to a single example where free trade has cost someone (anyone) their freedom of speech or their liberty? Just a single example?
Jose Pablo
May 12 2023 at 3:16pm
Liberty preserving industrial policies maybe as acceptable as pink unicorns or as tasty English food.
“The Chinese refused to trade” … every Chinese has the right to refuse to trade with whoever we wants to refuse to trade. The right wording is “The Chinese government prevented chinese citizens trading with ..
“Charlemagne did not want his people to trade …” the right wording should be “Charlemagne did not allow his people to trade …” (btw, ¿his? does Charlemagne owns them?)
How can be “prevent individual citizens from doing something they want to do” (for instance, trading with whoever they want) “liberty preserving”?
Looks like another example of the Hayekian “end of truth”
Richard W Fulmer
May 12 2023 at 11:19am
Good luck with that. When the government decides to regulate an industry, where can it go for people with experience other than the industry itself? When someone retires from the regulatory agency, where can they go for a second career other than the industry about which they’ve spent their professional lives learning? Moreover, regulators who know they may one day work in the industry they regulate have a strong incentive to remain on good terms with people in that industry.
Richard W Fulmer
May 12 2023 at 11:57am
Spence identifies “three main components” of the CHIPS and Science Act:
1- “[I]nvestment in science and technology and the associated human capital”
2- Shifting production “either to the US or to friendly or reliable trading partners”
3- Restricting “trade, investment and technology flows to China”
He leaves out a fourth component – a progressive wish list, imposed by the Commerce Department, that includes:
– Requirements that companies provide affordable childcare for workers
– Preferences for use of union labor
– Requirements that companies ensure workforce participation of economically disadvantaged individuals
At best, the requirements will increase the cost of the initiative and delay its implementation. At worst, it will ensure that the initiative fails. In either case, these administrative add-ons will serve as a template for future industrial policy projects.
Jose Pablo
May 12 2023 at 3:01pm
friendly or reliable trading partners
That’s a very interesting topic.
Before the world wars more than 80% of the German foreign trade was with Western European countries. That should mean Germany (and its European partners) considered their respective counterparts “friendly or reliable” … well, with hindsight …
Haven’t check the data but I firmly believe that in 1860 a significant trade was taking part between the Southern and Northern States of the US. Which should mean they both considered the other part “friendly or reliable”, … well, with hindsight …
Russia was the best Ukraine trading partner in 2010. Friendly and reliable … well, with hindsight
I guess politicians are pretty bad at assessing ex-ante, who is reliable and friendly and who is not, or really bad at restricting trading to the countries they consider “reliable and friendly”
… or maybe it is way too easy to assume that criteria that are very easy to apply with hindsight can be also, reliably used “ex-ante”.
That is a rookie mistake, and, yet so prevalent!
Jose Pablo
May 12 2023 at 2:37pm
The real question is not whether industrial policy is worth pursuing, but how to do it well.
That looks like a new example of a very prevalent idea among brilliant minds:
“The only problem of government intervention is that it has not been “designed” by me”
There is always somebody convinced of that. The well documented problem of past interventions is, you know, that they were not “designed” by somebody with my brilliance and my clarity of ideas. But if you follow my advice, the intervention will be great.
What can go wrong …
vince
May 12 2023 at 7:09pm
Industrial policy means different things to different people. Spence says : The objective of industrial policies is to alter market outcomes in ways that align them better with a country’s broader economic and social objectives.
From that perspective, even patent law can be industrial policy. It would help if there was a universal definition.
Jon Murphy
May 12 2023 at 7:31pm
There is a universal definition. How it is used by the Right and Left is quite uniform
vince
May 13 2023 at 12:16pm
Patent law?
Jon Murphy
May 13 2023 at 2:36pm
The definition of “industrial policy” is not “patent law.”
vince
May 13 2023 at 3:02pm
Of course industrial policy is not defined as patent law. The question is whether patent law can be industrial policy.
Jon Murphy
May 13 2023 at 3:49pm
It can be applied as part of industrial policy, yes. It can also not be.
Daniel B
May 12 2023 at 8:48pm
I think some of the commenters here are missing why Spence and others support industrial policy. There’s an Alexis de Tocqueville quote that I think is very relevant here:
It may easily be foreseen that almost all the able and ambitious members of a democratic community will labor unceasingly to extend the powers of government, because they all hope at some time or other to wield those powers themselves. It would be a waste of time to attempt to prove to them that extreme centralization may be injurious to the state, since they are centralizing it for their own benefit. Among the public men of democracies, there are hardly any but men of great disinterestedness or extreme mediocrity who seek to oppose the centralization of government; the former are scarce, the latter powerless. –Alexis de Tocqueville, Democracy in America (Alfred A. Knopf, 1956) Vol. II, pp. 307–308; qtd. in Sowell, Thomas. Knowledge And Decisions (p. 326). Basic Books. Kindle Edition. (Emphasis added).
In other words, when people advocate more power for the government – to implement an industrial policy or whatever the goal is – they imagine themselves to be the ones wielding power, or someone who is like themselves (in terms of goals, values, etc.). And of course they would never succumb to special interest pressures, or other flaws of industrial policy. Someone with their values and knowledge would surely overcome these temptations and obstacles.
The thing is, a lot of industrial policy supporters do want to do the right thing (Spence is probably included among this group). They do not want to be the pawns of interest groups. These honestly held good intentions are a seductive feature of industrial policy (and government intervention in general), in part because they always offer the prospect of “this time it will be different.” This time they will find someone to get the things they want done who will not choose temptation. This time they do have the knowledge and the means to prevent abuses and issues in the system they are advocating; they will not repeat the mistakes of previous industrial policy attempts because they have learned from them. So on and so forth.
Until we can address the underlying reason behind the support of industrial policy, then our criticisms are in vain. We need to become way more knowledgeable and interested in public choice (I certainly need to refresh my knowledge) so we can understand the political process better and see whether it really is true that these temptations can realistically be expected to be overcome. Someone needs to write a book in the style of Thomas Sowell’s Basic Economics but focused on public choice and filled with lots of real examples rather than theoretical ones. That will help people learn history, so they do not repeat it, rather than learning theory, which many people will not believe unless they see examples. It should be accessible and persuasive enough that it can actually influence people, just like that book did for me.
At a minimum we need to try to collect our knowledge of public choice and real world examples of it in action (whether from books or elsewhere) into one place to reduce the costs of searching for that information. This will help in presenting the criticisms of industrial policy because by reducing the search cost, we reduce the cost of discovering the information, so more people will discover it and hopefully more people will oppose industrial policy. Right now this information (and information against government intervention in general) is so horribly fragmented. We need to defragment.
Daniel B
May 12 2023 at 9:35pm
I just realized I sound pretty smug about them in the paragraph just after the quote. But that is not my intention. Besides trying to illustrate the implications of the quote, I’m trying to point out that we can easily rationalize things to ourselves. It’s easier said than done to resist temptation, including in the political process. And that applies to everyone, including me and others who are generally more critical of government interventions.
One problem with interventionism, however, is that it creates temptations (such as special interests wanting to have power used for their benefit). Maybe there will be a reduction in other temptations (such as not investing “enough” in an industry) that will be worth it. But the logic of the quote is evidence of how easily we can underestimate the risks of government power. One example: we generally overestimate how good we are as people (there are some references on this in Jason Brennan’s book Cracks in the Ivory Tower). Maybe we aren’t as strong in the face of political temptation as we might think… I certainly am worried about what I would do if I were in politics.
Jose Pablo
May 13 2023 at 2:21pm
Yes ….
but the fundamental problem of interventionism is even more basic.
In a market order there is no “objective function”. Every single agent tries to maximize his/her subjective utility. Yes, you can understand the temptation to “improve” this, somehow, “chaotic” outcome, “aligning it better with a country’s broader economic and social objectives“.
Very well but,
What does “better” mean? what is the “objective function” Spence is proposing to “optimize”? What “economic objective”?
It is not GDP since Spence himself says that these policies can “not align well with economic efficiency”
If it is “economic independence”, how do you measure that? How do you measure “resilience to foreign trade”? How do you that “centrally”? It is not about the agents understanding the impact of trading with providers in nation X or Z, on the resilience of their businesses, which is something they already do.
No, the “IP designer” now overrules the agents because he/she/they “know better” how to increase “resilience as a whole” … how come?
So, you don’t really have an objective function to measure the effects of the policies. You only mention empty concepts (“social”, really? … still playing with that?).
But it gets worse. The only thing you as an “IP maker” can really do is setting a set of constraints and/or incentives that you “think” would steer the agent’s behavior to do things that promote the ill-defined broader objectives that you want your IP to achieve.
So, you, as an IP maker have no objective variable and no reliable model that allows you to forecast the impact on your non-existing objective function of the actions that the agents are going to adopt (actions you don’t know and can only guess), following the enactment of the wording (and the loopholes) that you want to include in the set of rules than truly ARE your intervention.
It is clear this is all a line in the water. That only makes sense because what you are “selling” as a IP designer is “the way it sounds”, not what the policy really do (something you don’t know and will never know, because you don’t even have how to measure it (i.e. were European economies’ resilient enough for a war with Russia scenario? … it seems like they were since, after a lot of noise, nothing terrible has really happened)
To pretend, as Spence does, that a positive discussion can be held along these lines is a sophism of the worst kind.
steve
May 13 2023 at 12:57am
“I’m also not sure it’s a great idea to hold up covid vaccines as an example of a success given what a cluster they were. First, the vaccines were developed pre subsidies but sat in regulatory malaise for 6 months. When they were finally given EUA, the rollout was highly regulated and politicized and had nothing to do with who was at most risk or achieving social objectives. ”
This is wrong. They were going through Stage 3 testing. From the time everything was submitted until approved was 3 weeks, the normal time being 12 months. We ended up being one of the first countries to approve. There was a lot of talk about what groups should be prioritized but in the end vaccines were prioritized based upon age and major risk factors just about everywhere. There was also the issue of being able to produce enough vaccines. There were some govt financed standby facilities that the drug companies were able to use so that they could have large volumes once the vaccine was approved. OWS also played a part in increasing the production of vials, syringes and needles .
Steve
Jon Murphy
May 13 2023 at 5:34am
I don’t see how your comment proves me wrong. It supports my argument.
steve
May 14 2023 at 12:52pm
The drug companies would not have been able to produce much vaccines by the time they were approved without those pre-set up facilities. I guess you think we can skip stage 3 drug testing, which is something no drug company would do if given the option, unless maybe they were given safe harbor by the government. I actually doubt they would do it even then. So at best we could have had the drugs available a few weeks earlier if the approval process only took one day, but absent govt aid we wouldn’t have had much drug available. The only reason the vials were available, and syringes/needles, was because the govt intervened and paid those companies to start making them early. They would have responded eventually, but not in time.
Steve
Jon Murphy
May 14 2023 at 12:58pm
Why do you assume that? The empirical evidence says otherwise. Indeed, many firms were willing and able to ramp up production quickly, but the government wouldn’t let them (through price controls and other regulations).
Thomas L Hutcheson
May 13 2023 at 7:07am
“Flabby” is being quite mild.
While I agree with all of the specific criticisms, I think the fundamental problem is that he is arguing against the straw man, that there is a near universal belief among policy makers or those whose view count , held unthinkingly, that governments should intervene not and cannot intervene positively in economic affairs. The “neoliberal religion holds almost unquestioned alegiance. He has come to try to get the Neoliberal to doubt his faith, to consider the possibility that there could be positive government interventions. That his positive arguments are flabby is almost beside the point.
Monte
May 13 2023 at 11:03am
It seems a confluence of global events (climate change, Covid-19, the rise of China) has rekindled an interest in relying on Industrial Policy (IP), rather than the market, to restore U.S. competitiveness. For some perspective, the Peterson Institute for International Economics (PIIE) examined 18 high profile cases from 1970 to 2020. They determined that U.S. IP worked best when used to fund industry R&D:
Some here might also recall Project Socrates, a joint effort undertaken by private industry and government in 1983 to determine why the U.S. had lost its competitive edge:
Socrates was largely successful in its mission to determine the underlying cause of U.S. decline and to develop a solution, but fell out of favor during the George H. W. Bush administration and was ultimately defunded.
All this to say that IP is most effective when limited in scope and duration. To be fair, Mr. Spence did mention that IP should be “precise, limited, and clear.” The problem, to paraphrase Milton Friedman, is that there is nothing more permanent than a temporary government program. And one wonders, given his impassioned defense of it, whether Mr. Spence has an almost religious commitment to IP.
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