Thursday, August 12, 2010

Why? 'Cuz picking winners is bad, mmmkay.

There's an interesting article in this week's Economist, "Picking winners, saving losers" that deserves a read if you're a subscriber. If not, I would like to highlight a few points.

As expected, the Economist still finds industrial policy to be largely unsuccessful, though the evidence they present is only anecdotal. They say that industrial policy is back in fashion now for four reasons:
  1. Weakness in the world economy
  2. Efforts to rebalance economies away from sectors such as finance and real estate. (They mention the US here, but I see no evidence whatsoever that the US is trying to rebalance away from real estate. Indeed, I'm pretty sure everyone in Washington gets on his or her knees every night and prays for a rebound in the real estate market.)
  3. Emergency efforts to rescue recessionary economies has led to demands for more industrial policy
  4. Rich countries are responding to the apparently successful policies of countries like China and South Korea.
All of these reasons sound plausible, and I think the last one is one of the most important. Why? Because, despite all of the economic theory telling us industrial policy is bad, China is the elephant in the room that no one seems to know how to address.

Is China, with its "state-led capitalism", making a huge mistake that it will pay for in the future, or is it the exception that proves the rule? And if China is right, where does that leave all of the other countries that are hoping to abandon industrial policy as soon as the recession is over?

One of the Economist's concluding lessons (which it says are "clear") is that, "the more [an industrial policy] is in step with a national or local economy's comparative advantage, the more likely it is to succeed". Okay, so the Economist is allowing that industrial policy could work, but how can it explain the fact that some countries have successfully created industries where none previously existed?

If Japan and South Korea had listened to the Economist's advice about comparative advantage, neither would have an auto industry right now. Same goes for China. Everyone would still be farming in the countryside.

The article quotes a Michael Liebreich, CEO of Bloomberg New Energy Finance, on industrial policies currently supporting clean technology. "Where the industry ends up will inevitably be different from where the money went in," he says.

Despite the fact that China and the US are both spending piles of money on clean technology, says Liebreich, China is still likely to end up with most of the manufacturing, and the US is still likely to end up with most of the R&D -- the implication being that money spent on R&D in China and on manufacturing in the US is probably being wasted.

Again, though no hard evidence is offered to support Liebreich's prediction, this does seem about right. But it's only because I see no real evidence that China is willing to make the kinds of political changes that would create an intellectual environment where innovation is encouraged.

On the other hand, we also see a US government completely willing and able to spend a lot of taxpayer money to keep manufacturing at home. Without question, GM would not exist if the Bush/Obama administrations had not saved it.

Since I am not an economist, I'm not sure I have the tools to solve the questions of industrial policy. Then again, I'm not sure the economists do either. The only thing that's "clear" to me is that the real world keeps throwing out examples that their models cannot explain.