Industrial Policy Does More Harm than Good
Autor: FWG
Many governments are interfering more and more deeply in economic processes. Protectionism is on the rise in the world. The result could be a stagnant global economy.
Liberalism20.08.2024
Tadeusz Syryjczyk, Minister of Industry in Tadeusz Mazowiecki’s government in Poland, once stated that the best industrial policy is no industrial policy. This has caused an outcry from those who declare that industrial policy is a very important, if not the most important, part of economic policy. This has been strongly emphasized by Law and Justice (PiS) politicians, especially Mateusz Morawiecki, prime minister of Poland between 2017 and 2023, and politicians in the current ruling coalition seem to agree. Even the Polish Ministry of Industry, which existed from 1988 to 1991, was re-established. For now, it’s unclear what it is to handle.
Policymakers in other countries with longer experience with market economies than Poland are also not shying away from industrial policy. Donald Trump has vowed to revive U.S. industry and return factories previously relocated to countries where labor is cheaper and environmental standards are more lenient back to the U.S. Industrial policy is also much discussed in European Union programs, such as the Lisbon Strategy and Europe 2020.
Government “breeding” of enterprises
If by industrial policy we mean improving the business environment (this is the wording used in Strategy 2020), then we are dealing with a standard economic policy that does not necessarily refer to industry but also to services, construction, or transportation. Usually, however, those who speak of industrial policy have in mind state support for specific industries or even products that policymakers consider particularly important for the economy as a whole, innovative, cutting-edge. Support can take the form of protecting government-preferred companies or entire industries from foreign competition, giving them direct subsidies, tax privileges or inexpensive (subsidized) loans.
In other words – the government “breeds” companies in a given industry, providing them with the comfort of no real competition, at least for a while. This is not easy in our current conditions, as in the European Union, state aid is subject to control by E.U. institutions, and in addition, Poland, like the vast majority of countries, is a member of the World Trade Organization, which prohibits excessive state support of domestic production and sets upper levels of tariffs. Although more and more countries are not concerned about these restrictions (as will be discussed later), arbitrary state support of selected industrial plants is more difficult than in the mid-20th century.
The idea of promoting domestic industrial production to replace imported products was popularized in the 1950s by Argentine economist Raúl Prebisch. Many developing countries have adopted this strategy but have not been successful. In the 1960s, it became clear that import substitution policies, especially in Latin America and South Asia, led to the creation of heavily protected and inefficient domestic industries, hampering exports and reducing foreign exchange earnings. As a result, support for import substitution, at least among economic thought leaders, has begun to wane.
The instructive examples of India and South Korea
The failure of the government’s “breeding” of industrial plants is due to the fact that without market competition, it is very difficult to get companies to improve productivity, innovate, and produce quality products. If the government predetermines which company is to win, the winner doesn’t have to make an effort.
It is instructive to note the history of India, the economy of which is growing at a record high rate today, and which protected its companies from competition until the 1990s. India tried socialist experiments for several decades after independence, and its leaders were impressed by the USSR. Jawaharlal Nehru’s first government of independent India began pursuing a policy that has ironically been called the Kingdom of Licenses (“Licence Raj”) – a land of licenses, permits, and bureaucratic restrictions. The economy grew at a slow pace, which economists called the “Indian pace.” Only when the government gradually began to allow competition in the last decade of the 20th century did India begin to lift itself out of poverty.
South Korea is often cited as an example of a country that has achieved success due to its government’s policy of supporting its own industry. The state selected export products that were likely to succeed in world markets and their manufacturers. It created multi-year production development plans for each designated export good and export industries. Large family-owned companies – Chaebols – were given export targets set by the state, the achievement of which the state rewarded. Companies that did not show a willingness to cooperate in the implementation of five-year plans or did not carry out export plans already adopted were harassed by government agencies. They were subjected to burdensome inspections, credit was prevented, and factories were disconnected from infrastructure.
Between 1961 and 2010, South Korea’s GDP increased nearly 50-fold, allowing one of the world’s poorest countries to rise to the top 20 in the world in terms of GDP per capita. However, it is worth noting that Korea’s growth rate has slowed in the last ten years, averaging only 2.7 percent.
From the statements of some Polish politicians, it seems that South Korea’s development strategy should be a model for us. However, mistakes can be made when copying another country’s success strategy. This is because many factors influence success, and it is difficult to estimate their proper weight. It cannot be ruled out that the weight of some factors in Korea’s development was negative, and success was achieved not because of them but despite their existence.
The government’s interference in South Korea’s economy has caused many investment decisions made under government pressure to be erroneous. The capacity of shipyards and the steel industry has been overextended. Chaebols have grown to such a size that no financial institution in the country has been able to meet their huge demand for loans. Thanks to unclear capital ties within the Chaebols, companies were able to guarantee each other’s loans. As a result, the debt has exceeded its value several times over.
When the financial crisis erupted in East Asia in 1997, it also affected Korea. Between 1997 and 1999, 11 of the 30 largest Chaebols went bankrupt, including Daewoo, Korea’s second-largest conglomerate. Korea required international assistance.
Can an official accurately predict market processes?
Mateusz Morawiecki, who advocated state interference in economic processes as prime minister of Poland, cited the concept of “new structural economics,” created and promoted by former World Bank chief economist Justin Yifu Lin. Lin heads the Institute for South-South Cooperation and Development and the Center for New Structural Economics at Peking University and advises the Chinese government on economic policy.
“The new structural economics” is supposed to be a smarter form of industrial policy. Traditional industrial policy supported industrialization through tariff policies and public subsidies, whether or not the companies thus built were profitable and competitive in world markets. The new structural economics recommends state aid only for competitive sectors and companies. The problem is that someone has to determine which sectors and companies are competitive and which are not. That someone is an official or politician. The probability of making an error in forecasting market processes is very high.
Although it is difficult to provide examples of successful industrial policies, many governments are interfering more and more deeply in economic processes. The principles of the Washington Consensus, which recommends low budget deficits, free international trade, and flexible exchange rates, are also being violated by the governments of developed countries. Protectionism is on the rise in the world.
The reason is the global upheavals that have occurred in recent years: the pandemic, the war in Ukraine, and disturbances in energy markets. Multinational corporations have realized that they need to appreciate geopolitical risks more and are withdrawing production from some countries. This process can occur spontaneously and be the result of decisions made by corporate boards. However, politicians have recognized that they should assist this process. Climate policy is also a pretext for protectionism and subsidizing certain industries and companies.
U.S., E.U., China – subsidy race
In the United States, Congress passed the following laws in recent years: CHIPS and Science Act and The Inflation Reduction Act (IRA). The first authorizes the government to allocate some $280 billion to boost domestic semiconductor research and production. Contrary to its name, the IRA has little to do with the fight against inflation. It provides about $370 billion in grants and tax credits for energy savings and energy transition.
Scott Lincicome, Vice President of the Cato Institute, notes that by the time the laws were passed, the pandemic, geopolitics and other market factors had already increased companies’ interest in diversifying their semiconductor sourcing. Private investment in green energy also grew rapidly. Additional investment growth stimulated by government subsidies accounts for only a small portion of total private investment and GDP. Lincicome also says that despite government subsidies, the U.S. manufacturing sector has been stagnant since 2022 due to higher interest rates, continued increases in material prices, declining labor availability, economic uncertainty, tariffs and trade disputes, burdensome regulations and other obstacles. High interest rates are the result of soaring public debt.
Under the IRA law, tax credits are given to households installing zero-emission energy sources and to U.S. manufacturers of electric cars and batteries. In November 2022, Thierry Breton, EU Commissioner for the Internal Market, stated that the United States was starting a “subsidy race” through investment incentives offered to companies by IRAs. As a result, tensions between the United States and the European Union began to rise. As part of this race, a huge solar panel factory owned by Enel SpA is being built in Sicily. This Italian energy company is one-quarter owned by the Italian Ministry of Economy and Finance.
The IRA is also part of the U.S. economic war against China, whose economic policies are opaque, and it is difficult to calculate the exact scale of subsidies for solar panels and electric cars. The perception in America and Europe is that the scale is huge. So, tariffs are being introduced on Chinese products.
The primitive industrial policy pursued by the communist countries allowed for a huge increase in production capacity, especially in heavy industry, but ultimately led to a deep economic crisis. The collapse of communism coincided with the triumph of free market ideas. Their fruits were a wave of privatizations, lowering tariff barriers and subsidies. As a result, the world has experienced several decades of rapid development, benefiting poorer countries in particular, including Poland. Today, barriers, government subsidies, and regulations are increasing in many countries. The result could be a stagnant global economy.
Witold Gadomski – Polish journalist, “Gazeta Wyborcza” columnist
The article is part of the Economic Freedom Foundation’s series “Through the Eyes of a Liberal” and also appeared on Wyborcza.pl.
