Freeman

ARTICLE

Industrial Policy

MAY 01, 1985 by WILLIAM L. ANDERSON

During the 1984 election season, Industrial Policy became a catch-phrase as candidates outlined their economic positions. Since the elections have now passed (at least for two quiet years), the phrase is not bounced around in the news columns as before, but advocates of Industrial Policy are as anxious as ever to see their ideas come to fruition. Thus, their ideas bear watching and those who see this particular policy initiative as potentially disastrous to our economy should try to obtain whatever intellectual and political ammunition is available to see that Industrial Policy remains only an idea.

Throughout this paper I shall be critiquing the so-called Industrial Policy ideas, but before I criticize I shall give the readers a general description of what these ideas are and how they would be implemented.

First, it should be noted that Industrial Policy advocates such as Harvard University’s Robert Reich, Barry Bluestone of Boston College, Senator Gary Hart and business executive Lee Iacocca see American industry in decline: our basic industries such as automobiles, steel, rubber and textiles are falling prey to subsidized or outright government-owned foreign competition. The loss of such jobs, they contend, means the end of the American mid-die class as we have known it, and further erosion of the job base will relegate us to low-paying service jobs such as keyboard punching and hamburger flipping. America the once-powerful and wealthy will become America the exploited colony.

Second, advocates see Industrial Policy as fitting into a broader picture of “quality of life,” which emphasizes things like health care, support services, paid vacations, environmental purity, welfare compensation and other such amenities that “protect” us from the often harsh realities of life. Government planning and intervention, they argue, can help raise the standard of living for most, if not all, of us by providing more quality of life services.

Specific Industrial Policy implementations would include the following:

(1) Increased government spending in health care, unemployment compensation, worker retraining, housing and relocation for displaced workers.

(2) “Domestic Content” legislation for automobiles as well as increased “protection” for other domestic producers that must compete with foreign firms both in the U.S. market and abroad (included in this package would be a broad range of subsidies both for exporters and firms that sell mostly in this country).

(3) Increased (or targeted) regulation of U.S. firms, especially those in the transportation industry to insure “stability” in the marketplace.

(4) Reinstitution of the Hoover-era Reconstruction Finance Corporation that would make low- interest loans available to “threatened” U.S. firms.

(5) Restrictions on plant closings to keep firms from shutting down unprofitable plans or enterprises in one area of the country and moving them to a more suitable business climate either in this country or in a foreign land.

(6) Expanding labor union power, giving “participatory rights” to workers in the decision- making of the firms where they are employed as well as providing workers’ groups with low-cost liquid capital to enable them to buy plants that are closed or are being closed.

(7) Targeting of potentially profitable new firms (such as high-tech companies) by giving them “protection” as well as low-cost capital.

Interventionism

Of course, any observer of government intervention into our economy can readily see that government has, at one time or another, followed the above scenario. Government expenditures for health care and unemployment benefits have steadily increased since the 1960s. Protectionism has been a part of Federal policy since the founding of our republic. The regulatory monster has expanded its reach for nearly a century, and government support of unions has guaranteed organized labor a far larger share of the work-force than it would have if unions were forced to compete in the marketplace the way firms compete for workers.

But the advocates of Industrial Policy recognize this fact as well. They, too, admit that government already intervenes in the ways specified previously and further admit that intervention can even be harmful at times. The choice, they say, is not between intervention or nonintervention; rather, we must choose between “smart” policy and “stupid” policy.[1] Stupid industrial policies, the advocates say, disintegrate into a chaotic mixture of zero-sum clashes between competing sectors of the economy.[2] Smart policy, they say, brings the different sectors together in a coordinated effort. The key, of course, is to know the difference between that which is “stupid” and that which is “smart,” then have the political conviction and courage to see that Congress implements these policies. As Reich has noted:

America has a choice: it can adapt itself to the new economic realities by altering its organization, or it can fail to adapt and continue its present decline. Adaptation will be difficult . . . . A new consensus is difficult to achieve when each person seeks to preserve his standard of living but finds that he can only do so at the expense of someone else. But failure to adapt will rend the social fabric irreparably. Adaptation is America’s challenge. It is America’s next frontier.[3]

Examples given by industrial policy advocates include the so-called success of the Japanese Trade Ministry, or MITI, and (if one can believe it) American farm policy. Both cases, the advocates write, show that by coordinating private businessmen and government officials, an entire economy can benefit from new success and productivity. Most important, they say, is that the new efforts at Industrial Policy are not a case of the private sector versus the public sector, as is the case of socialism. Rather, they note, the key word is “coordination,” or, perhaps, a “public and private partnership.”

Partnership?

To those who have become weary of the false battles of “public interest” against the “private interest,” such a proposed partnership might bring some relief. The truth is, however, this so- called “partnership” is every bit the assault on the private economy that has come with decades of socialist planning. At best, Industrial Policy is a naive idea that will be rendered harmless by public indifference and its greatest sin will be that of wasting a valuable commodity called paper. But at worst, Industrial Policy will bring about large distortions and misallocation of capital in the economy while, at the same time, increasing the already intolerable mass grab for funds from the Federal treasury and pushing productive entrepreneurship underground.

Distorting the American economy is the last thing on the minds of the Industrial Policy promoters. After all, they say, the idea is to help, not hurt our economic prospects. One might ask, “How can anything so destructive come out of something meant to do so much good?”

To refute the promoters’ claims, then, we must show the ways in which such policy implementation will cause damage to the economy, as well as demonstrate the difficulty of putting such legislation in force. Before dealing with those subjects, however, we will first examine the two examples of success cited by policy proponents.

Learning from Japan

When viewed with a critical eye, the so-called magic of MITI fades into political and economic reality. This is not to say that MITI has not had some success, but most likely those Japanese success stories would have occurred even if the bureaucrats in the trade ministry had not “targeted” the semiconductor industry, among others.[4] What is more important, however, is what MITI failed to accomplish—to the relief of the Japanese. In the early to mid-1970s, MITI attempted to persuade Japanese investors to target the steel and petrochemical industries rather than the automobile industry, which MITI declared could never be competitive with U.S. auto manufacturers on an international basis. As we know today, Japanese steel stays alive mainly because of government support while the Japanese automobile industry has become the envy of the industrialized world.[5]

No wonder, then, that Economist Katsuro Sakoh said that the recent economic success of Japan is “based not on how much it [the Japanese government] did for the economy, but on how much it restrained itself from doing.”[6]

As seen by the recent wave of farm foreclosures-coming at a time when record supports are being paid to farmers—one is hard-pressed to comprehend the excitement Industrial Policy proponents have for farm programs. Yet, Economist Lester Thurow, an ardent supporter of interventionism, has written, “In agriculture what started as a desperate effort to prop up a very large, sick industry in the 1930s ended as an industry that is the world’s most efficient. There is no reason that feat cannot be duplicated elsewhere.”[7]

In answering Thurow’s glowing endorsement of farm policy, Richard McKenzie, an economist from Clem-son University, comes directly to the point:

What such advocates fail to report is that we have an agricultural policy that props up the price of food for the rich and poor alike, that adds to the impoverishment of the lower-income groups in this and other countries, that contributes to the destruction of the soil base, and wastes a monumental amount of food—all in the interests of appeasing a very powerful political interest group.[8]

McKenzie touches on the point of interest groups made by Reich, but unlike Reich, he understands the nature of interest groups and is fully aware that appeasing such groups is not costless. For even if one ignores (and we will not do so in this paper) the economic illiteracy shown by Industrial Policy advocates, it is impossible to bypass their political naiveté Their fallacy is simply the fallacy of composition; that is, they forgot that what may be good for one special interest group is not necessarily good for the public at large. Farmers who receive supports from the federal government no doubt personally benefit, but the benefit is not shared by the public. Rather, the public must pay for this transfer of wealth through higher taxes and higher food prices. To give such support to every sector of the American economy simultaneously is virtually impossible, since there would be no sector left to plunder. Instead, such universal support would be an act of self-plunder, of everyone attempting to prosper at the expense of everyone else.

Industrial Policy proponents totally misread the true nature of government. In the view of those who believe government is the best tool to correct so-called “market failures,” according to economists Robert E. McCormick and Robert D. Tollison, “the state is a productive entity that produces public goods, internalizes social costs and benefits, regulates decreasing cost industries (monopolies) effectively, redistributes income Pareto optimally (giving to some without hurting others), and so forth.”[9]

A Flawed Theory

But McCormick and Tollison, through their studies of government, find that such an approach “is not a very believable theory of government action and, moreover, that it is flawed by the unwarranted assumption that government can be called upon to correct imperfect markets in a perfect and costless man-net. That the state is not a perfect instrument for correcting market failures hardly needs demonstration . . . . Indeed, although imperfections in the economy may be lamentable, lamenting is the best that can be done if the consequence of government action is to decrease rather than improve economic welfare.”[10]

As stated earlier, Reich acknowledges the impact of interest group behavior (called “rent seeking” in economic jargon), but then declares that Americans must “adapt” to “new economic realities,” as though a few exhortations to unselfishness by (self-interested) politicians can change things. But the truth is, people who have their hand firmly placed in the Federal cookie jar, along with those trying to jam their own hands into the chaos, will not suddenly turn altruistic because a few intellectuals write books. It must be remembered that the fallacy of composition works both ways. Most handouts to special interest groups constitute a small part of the Federal budget—that is, by themselves. Particular groups asking for more Federal money, protection, or the like usually preface their requests with an acknowledgment that whatever portion comes to them will be only a minute part of the budget and that cutting out that giveaway will have almost no effect on efforts to balance the Federal budget. And, most importantly, such groups are firmly aware of the old adage that governments grow “because the benefits are concentrated and the costs are diffused.” They argue, “See the good this program will do for us, yet the cost to the taxpayer is very minimal.”

Behavior at the Margin

If the case is seen as being isolated from the rest of the budget, then the argument makes sense. But economics and the study of political and economic behavior does not simply concentrate on total spending or total outlays. Rather, studies emphasize behavior at the margin. That is, when we look at the total budget picture, we view it as the sum of every little program (plus the gargantuan ones as well) that Congress slips into law. Any one of those programs by itself constitutes only a small fraction of total spending; added together, however, the programs be come part of a budget out of control.

Can such rent-seeking behavior be changed through exhortations by politicians and intellectuals? Hardly. If one views the present budget picture as the political norm, the prospects for ending the interest-group giveaways are not bright. For one, neither intellectuals nor politicians are free of rent-seeking qualities. In the case of the politician, he or she is part of a barter system that trades favors for votes. Politicians are fond of asking for budget restraint—in someone else’s district; they like to seek tax increases—far away from their constituents. Intellectuals, on the other hand, are not free of government largess themselves. Universities are perennial grant recipients, as are particular professors who receive Federal monies for their own pet studies. And, finally, there is the issue of power. One can readily surmise that if the federal government were ever to implement the version of Industrial Policy advocated by the proponents, those in charge of overseeing the resulting programs would be the very intellectuals who are interested in seeing the programs come to fruition.

Thus, one can be sure that the initiation of a so-called comprehensive plan of Industrial Policy would not end the destructive rent seeking that presently characterizes our budgetary process. Instead, it would give government intervention a new respectability at a time when the realities of intervention are proving just how harmful intervention and regulation has become. And as the political process would steadily worm its way into the decision-making of the Industrial Policy czars, the facade of economic impartiality would crumble until nothing remained but rent seeking and interventionism.

Economic Fallacies

Plans of Industrial Policy can be criticized as in conflict with political reality. But those plans contain a multitude of economic sins as well, a mountain of errors which will be discussed next.

The first challenge to the so-called need for Industrial Policy deals with the very claims that America is in the throes of deindustrialization. This challenge is vital because it attacks what proponents see as the basic reason for implementing Industrial Policy in the first place.

While it is true that many of America’s factories have shut down in recent years, many on permanent shutdown since the 1981-82 recession, one must keep those facts in perspective. For one, much of the unemployment in this country is concentrated in heavily unionized industries, including manufacturing and mining. (The construction industry—much of which is unionized—also suffers from high rates of unemployment, but high unemployment rates in that industry are common, due to a large number of economic factors.) Because of the nature of unionism, such high unemployment rates are predictable, especially given the militancy of union leadership in this country. The higher-than-average wage of the union worker helps bring about unemployment in two ways. First, as economic theory predicts, the high price of unionized workers forces the company to hire fewer employees than it ordinarily would have hired had market rates, rather than coerced wage rates, prevailed. Second, the high wages make it attractive for other workers to seek union work, as well as making it attractive for laid-off union workers to remain unemployed until being recalled. Thus, the high rates of unemployment in unionized sectors.

But unionization has other negative effects on industry as well. Most of the recently closed plants were shut down because they lacked the needed capital to operate profitably. Unions have long been known to resist recapitalization in plants because such retooling often leads to a smaller workforce in those particular factories, which equates to less membership in unions. Therefore, plant owners and managers have often had to limp along in a high-technology age with yesterday’s capital. While the economy was booming, such problems could be masked; when the latest recession hit, however, the party was over and old, obsolete plants closed by the hundreds.

No Mass Migration

This is a grim picture, but does it translate into the claim by Industrial Policy advocates that there is at present a mass transfer of jobs from the Northeast (snowbelt) to the South (sunbelt)? No doubt, some firms are relocating facilities from the Midwest and Northeast into the South. But the so-called massive transfer claimed by the Industrial Policy proponents just is not happening. Richard McKenzie points out that New England’s manufacturing employment rate in the latter 1970s grew at a compound annual rate of 3.46 per cent, which was 50 per cent more than that of the South Atlantic region. This was no simple wealth transfer; rather, it reflected the growing high-tech boom and the ability of the New England states to provide such firms with a labor force that could match the job requirements.

In fact, according to U.S. Department of Labor Statistics, projections show the distribution of manufacturing jobs in this country to remain relatively static through the rest of this decade.[11] While it is true that certain changes, some pleasant and some not, are occurring on the micro level of our economy, the broad picture is that the U.S. economy is strong. True, there is a small but significant growth rate in the service economy, but this growth is a sign that we are becoming wealthier, not poorer as Industrial Policy proponents tell us.

This is because the growth of services tells us that we need not era-ploy huge numbers and proportions of our population in basic manufacturing jobs as was required in years past. The growth of fast food restaurants, for example, is not a threat to our well-being, but rather reflects the fact that Americans are eating out more, a sign of greater disposable income. The same can be said of numerous other service industries as well. Because our manufacturing base is efficient, and because low-cost foreign firms see this country as a strong market for selling their products, we are able to buy basic items at far less cost (in percentages of personal income) than could our forebears. This means that we have money left over to eat out or put-chase services becoming more and more available to us. And as the potential for service industries continues to grow, the opportunities for new kinds of employment grow as well.

Those who declare that the increase in imports and the growth of service employment threaten our well-being forget that foreign firms will sell here as long as they believe they can receive something in return. Japanese auto manufacturers, for example, are not philanthropists; they do not sell us high-quality, inexpensive automobiles out of altruism. Rather, they seek goods and services in return and if the day comes that we have no manufactures or if all of us are turning over hamburgers at the local fast-food place, the Japanese or any other foreign producer will look elsewhere for new markets (or the Japanese will undergo massive changes in their dietary habits—highly unlikely).

The actual implementation of Industrial Policy, judging from what has been described about the rent-seeking aspects of the political process, would be nearly impossible. But, for the sake of argument, if it were actually put into law, could it succeed? That is, are opponents actually afraid that such an initiative could be more effective than free markets, thus discrediting a whole body of economic literature and its authors?

If the writings of Nobel Laureate Friedrich A. Hayek are to be believed—and economic history has yet to discredit Hayek’s work—the answer is a flat no. First, and most important, Hayek has shown time and again that centralized planning cannot replace the efficiency of the marketplace, and his writings have been proven by the unqualified market failures of socialist economies.

The Role of Knowledge

A recurring theme in Hayek’s work is the role of knowledge in economic processes, a theme recently emphasized by economists Israel Kirzner and Thomas Sowell.[12] Hayek points out that while economic knowledge can be centralized in a few areas, it cannot be centralized when dealing with the entire workings of an economy. As McKenzie notes:

The mental capacity of our leaders is limited. They are capable of digesting only so much information intelligently. Central control of the economy will ultimately be restricted by the mental limitations of our elected and appointed leaders, even though they may be the “best and the brightest” among us. Growing complexity in products and productive processes, which is forecast by industrial policy proponents, will necessarily make us more, not less, dependent upon decentralized decision-making. This is because the growing complexity of production means that our leaders will be less capable of knowing and handling the entirety of the complex information that is known by others.[13]

No doubt the Industrial Policy experts are bright, intelligent persons. Few persons would deny that fact. However, the U.S. economy will not function better just because intelligent, highly- educated men and women are trying to centralize economic decisions. Rather, these decisions are better left to those who, while lacking high-powered college degrees, are far more capable at understanding their own economic surroundings than someone in Washington, D.C. As Sowell has noted, we need the skills of all persons in the economy, not just the skills of a chosen few.[14] Centralized knowledge simply cannot replace decentralized knowledge.

Another serious flaw in the economic reasoning of Industrial Policy advocates is their failure to understand the problems of economic malinvestment, a problem that has been analyzed by Austrian economists since the beginning of this century. The outline of Industrial Policy calls for “targeting” growing or promising sectors of the economy with protection from foreign (and some domestic) competition as well as making cheap capital available. It is this portion of the plan that makes malinvestment a virtual certainty.

First, there is an inherent contradiction in the advocates’ analysis. For a new industry to have promise, it must perform well in the marketplace, for the market is the only true bellwether for any product. If people do not see a use for a new product or service, if they believe that the new item cannot meet their present or future needs, then that item has no future in the marketplace. Because the market reflects the needs and wishes of large numbers of people, it is by far the best way to measure the promise of a product or service. No other method is comparable. Even if a government official declares an unpopular item to be a new member of the marketplace, there is no guarantee that the item will ever be used in large quantities if at all.

Therefore, the best that economic planners can do in determining the potential for a new product or service is to make their determination after the fact. Their decision cannot precede the market’s verdict; it can only follow. With that in mind, it is important to realize that the market, and only the market, can truly pick winners and losers. For government to do so can have disastrous results. Farm price supports, for example, have made farming an attractive business for some investors because they were already guaranteed a price for their product—provided they could produce it. The lure of guaranteed prices has brought so many producers into the market that even government policies have not been able to keep prices at profitable levels. The result has been a 1930s-style liquidation of the Farm Belt (made vividly clear by recent news reports).

The same scenario would repeat itself anywhere the government tried to “target” what it perceives to be promising producers. The lure of easy capital and protection would entice new entrants into the market, and the resulting glut of production would bid input prices up and drag profits down. To put it bluntly, if the U.S. government were to give the same kind of support to the semiconductor industry as it presently gives to farmers, that industry would be flat on its back within a short time. The policies of easy money and protection would bring about massive malinvestment of capita], a malinvestment that would sooner or later have to be liquidated when the market would correct itself.

Of course, malinvestment and liquidation are impersonal terms. A human translation of them would include words like unemployment, joblessness, depression, and the like. For the price of malinvested capital must ultimately be paid by human beings, and it is the poor who suffer most.

On a large scale, as both Hayek and Ludwig von Mises have pointed out, malinvestment of capital has led to every one of our recessions in this century, and the central culprit in each period of capital malinvestment has been government policy, both fiscal and monetary. The new Industrial Policy promises to be a repeat of former mistakes and a guarantee of more recessions.

Thus, Industrial Policy is not a new promise of prosperity and a new age of American industry. Instead, it is simply, as McKenzie puts it, a hoax. Granted, the deception is not deliberate, but it is deadly all the same.

Government planning cannot substitute for the market at any time, even when one perceives problems of “market failure.” The market will ultimately speak; it is up to us to be sure that the words it uses include prosperity and wealth instead of depression and unemployment.


1.   Lester Thurow in Industrial Policy debate with Dr. William H. Peterson in Chattanooga, Tennessee, March 19, 1984.

2.   These ideas are put forth by Lester C. Thurow in his book The Zero-Sum Society, in which he sees government being pulled apart by competing special interest groups.

3.   Robert Reich, The Next American Frontier (New York: Times Books, 1983), p. 21.

4.   Richard McKenzie, “The Great National Industrial Policy Hoax,” lecture given at Notre Dame University November 17, 1983, pp. 11-12.

5.   Ibid., p. 12.

6.   Katsuro Sakoh, “Industrial Policy; The Super Myth of Japan’s Super Success,” Asian Studies Center Backgrounder, No. 3 (July 13, 1982).

7.   Thurow, “Farms: A Policy Success,” Newsweek,, May 16, 1983.

8.   McKenzie, p. 15.

9.   Robert E. McCormick and Robert D. Tolli-son, Politicians, Legislation, and the Economy (Boston: Martinus Nijhoff Publishing, 1981), p. 3.

10.   Ibid., pp. 3-4.

11.   McKenzie, pp. 9-13.

12.   Both authors have made extensive use of Hayek’s analysis on knowledge, Kirzner in Perception, Opportunity and Profit, and Sowell in Knowledge and Decisions.

13.   McKenzie, p. 15.

14.   Thomas Sowell, Pink and Brown People and other Controversial Essays, (Stanford: Hoover Institute, 1980).

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May 1985

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