In late 1983, when I was in my second year as a senior economist with President Reagan’s Council of Economic Advisers, I was tasked with writing the chapter on “industrial policy.” Industrial policy was all the rage back then. Various politicians, especially Democratic ones, advocated the idea. Among them was former vice president Walter Mondale, who seemed to have the best odds of winning the Democratic nomination for president and who, in fact, did win the nomination. So we knew it was a hot issue and my two bosses, chairman Martin Feldstein and member William Niskanen, decided that we should devote a whole chapter to the issue.
The essence of industrial policy is that government officials, looking ahead, predict which industries will or should do well, and then use various policy instruments—tax policy, subsidies, subsidized loans, and regulation—to move the economy in what they think is the best direction. They are, in Adam Smith’s words, updated, “men and women of system.”
There are two problems with industrial policy: information and incentives. Government officials don’t have, and can’t have, the information they need to carry out an industrial policy that creates benefits that exceed costs. Also, they don’t have the right incentives. If they spend literally billions of dollars of government revenue on buttressing an industry and the industry fails, they don’t suffer any personal wealth loss and don’t even lose their jobs. The only cost to them as individuals is their prorated share of tax revenues, which will typically be no more than a few hundred dollars. So what ends up happening is that subsidies and preferential treatment are given to the politically powerful, which reduces the amount of capital available for unsubsidized entrepreneurs and innovators.
This is from David R. Henderson, “Why Industrial Policy Fails,” Defining Ideas, October 26, 2023.
Read the whole thing.
READER COMMENTS
steve
Oct 30 2023 at 9:53am
Just a bit OT but executives are often given large severance packages at the time they sign. Since they are well rewarded even if their company fails has that had a negative effect on economic performance?
Also, dont they (politicians) risk losing re-election? Are there any examples of government investing heavily in an industry that failed? I am aware of individual companies. IOW if we look at this pragmatically comparing industries in which government has invested what is the track record?
Steve
Jonathan Murphy
Oct 30 2023 at 12:30pm
I don’t know the literature off the top of my head, but the result will probably depend on the details of the contracts. Presumably, the board would structure the contract so that the greater reward is to perform well.
Vivian Darkbloom
Oct 30 2023 at 3:23pm
“Presumably, the board would structure the contract so that the greater reward is to perform well.”
I don’t think that rebuts Steve’s point. An employment agreement that provides the same incentives on the up-side but without a severance package would be an even greater incentive to perform well.
Kevin Corcoran
Oct 30 2023 at 4:53pm
As I understand it, the reasoning behind “golden parachutes” is something like this.
In order for companies to grow, succeed, and thrive, executives need to be able to innovate and take the company in new directions as need by. However, innovation is risky – it might be a roaring success, or it might fail spectacularly. When executives are worried that they might be removed for a failed attempt at innovation, they may choose to play it safe rather than take a risk. Thus, it’s better if executives know they have a sort of “insurance policy” against failed risks. While it may be the case that an executive being “well rewarded even if their company fails” may have a “negative effect on economic performance” in individual cases, what’s even worse for overall economic performance in the long run is when executives are unwilling to take risks in the first place.
Thus, it may not be the case that “employment agreement that provides the same incentives on the up-side but without a severance package would be an even greater incentive to perform well.” It may only provide a greater incentive to play it safe compared to other companies that are willing to risks on innovation – and ultimately lead to worse performance overall.
Theoretically, it could go either way. Maybe companies that only provide up-side incentives with no severance package will perform better overall. Or maybe companies that provide both will do better overall. That’s the sort of thing that can just play out in the market – let both systems compete against each other and see which is more successful in the long run.
Vivian Darkbloom
Oct 31 2023 at 3:03am
“…the reasoning behind”
I suspect that I’ve had a great deal more experience with the corporate world than you have and enough to know that in reality “…the reasoning behind…” is simply a cover for a more mundane reality. If you’ve ever served on a publicly- traded company’s board, or even advised them, or even been around them enough, I think you’d know that the “…reasoning behind…” in that incestuous world is simply that if you scratch my back, I’ll scratch your’s”. How’s that for an incentive?!!
Jonathan Murphy
Oct 31 2023 at 7:51am
I may be just dense but I don’t see how that changes Kevin’s point.
Kevin Corcoran
Oct 31 2023 at 9:52am
Yes, I once believed that what you’re describing was the case too. But, as his wont, Thomas Sowell pointed out that explanation makes predictions that don’t match what we observe in practice:
Vivian Darkbloom
Oct 31 2023 at 10:11am
Also:
“In order for companies to grow, succeed, and thrive, executives need to be able to innovate and take the company in new directions as need by. However, innovation is risky – it might be a roaring success, or it might fail spectacularly. When executives are worried that they might be removed for a failed attempt at innovation, they may choose to play it safe rather than take a risk. Thus, it’s better if executives know they have a sort of “insurance policy” against failed risks. ”
If this were really the case, then companies, not prospective employees, would be insisting that generous severance packages be included in employment agreements. (Prospective Employer to Prospective Employee: “We insist that you accept our generous severance package because we want you to take more risk in the interest of the company and its shareholders!”)
As for “golden parachutes”, that term arose to describe provisions that protection to key employees in the case of a corporate takeover (in which, often, the acquiring company executives take over the key positions). This, also, has nothing to do with “encouraging risk-taking”.
Jonathan Murphy
Oct 30 2023 at 8:41pm
I think it does answer his question. True, one without the severance package would be a greater incentive, but since the market for CEOs is competitive, a firm may not be able to offer that.
steve
Oct 31 2023 at 3:04pm
Sowell’s comment makes no sense to me. In either situation, maybe even more so when a company is effectively owned by a few large investment groups, there is a high risk of of a small group of people sitting on boards making sure they all do well. I find it interesting and disappointing that this is what he offers rather than empirical evidence that companies that do not have large severance packages, do better. Also, it’s not all about risk taking, but taking the right risks. If you are walking out financially whole no matter what you do there isn’t much need to accurately assess risk. Might as well swing for the fences. Note that employees dont get this same safeguard.
Also, how many really large investment firms are really spending their own money. Pretty sure Fidelity is investing other people’s money. (Just realized I am repeating Vivian but I think the point stands.)
Steve
Richard W Fulmer
Oct 30 2023 at 1:56pm
Germany’s investment in green technology (it’s much touted “green industrial policy”) hasn’t yet failed, but the signs aren’t good:
Germany went from envy of the world to the worst-performing major developed economy. What happened? – ABC News (go.com)
robc
Oct 31 2023 at 11:15am
Canals?
There was a big time difference between the investment and the failure, but trains pretty much put canals out of business, both in the US and the UK.
There are exceptions, like Panama and Suez obviously. But that is because trans-oceanic shipping is still a big deal. Cheaper air freight or teleportation would put both of them out of business despite government investment.
Monte
Oct 31 2023 at 12:18pm
U.S. IP aimed at improving several industries against foreign competition failed:
Specific examples include Synthetic Fuels Corp, Solyndra, and Crescent Dunes.
steve
Oct 31 2023 at 3:11pm
Canals? But the government also vigorously supported trains. So if we do net ROI then I think the government comes out ahead. I dont know much about steel policy other than the tariffs but am familiar with the successes of DARPA, the spin offs from NASA and pretty heavy govt investments in the computer world and health care. On net they appear pretty positive. It seems like someone should have a spreadsheet somewhere adding up the pluses and minuses. I know that people like Boudreaux emphasize economic thinking but I like to see numbers.
Steve
robc
Nov 1 2023 at 12:06am
The numbers are great. But first you have to figure out the unseen numbers.
How much didnt get developed because of money diverted to the Apollo program? Or the Manhattan project?
David Seltzer
Oct 30 2023 at 11:24am
Government planning industry policy is met with the unintended consequence of regulatory capture. Implied in industry police; heavy-handed threat of overregulation. See Jon Murphy’s The FTC’s Confused Case Against Amazon.
Thomas L Hutcheson
Oct 30 2023 at 12:27pm
The knowledge problem would be partially solved by identifying what it is that is preventing the “right” industries to “require” industrial policy assistance and then design a policy to remove that obstacle. For example, we need and “industrial policy” for long-distance electrical transmission because NIMBYs and NEPA make the investment too risky. So the industrial policy is to reform NEPA and who knows what to overcome NIMBYs.
Richard W Fulmer
Oct 30 2023 at 4:24pm
Is that an industrial policy or just deregulation?
Another regulatory issue is the government’s apparent hostility to domestic mining. We’ll need a lot of copper, steel, and aluminum to build transmission lines to the tens of thousands of new wind turbines that the current Administration demands. But our government seems to want mining to happen overseas where environmental standards are much lower than they are here. A policy of “emit more elsewhere” makes no sense if we are to address a global CO2 emissions problem.
john hare
Oct 30 2023 at 5:46pm
A system in which NIMBY causes more hardship on the instigators than their victims would be nice. Can’t remember the meaning of NEPA.
Monte
Oct 30 2023 at 10:36pm
Compulsive Gambling, also called gambling disorder, is the uncontrollable urge to keep gambling despite the toll it takes on your life. Gambling means that you’re willing to risk something you value in the hope of getting something of even greater value.
Industrial policy (IP), also called government intervention, is the uncontrollable urge to intervene despite the toll it takes on the economy. IP means that the government is willing to risk something we value in the hope of getting something of even greater value.
Never mind that IP failures vastly outnumber IP successes. The revolution has begun. We must forget the past, and allow the government to place our bets on the roulette wheel of IP.
steve
Oct 31 2023 at 3:12pm
Awesome! You are making strong declarative statements. Could you share your lists of failures vs successes?
Steve
Monte
Oct 31 2023 at 4:10pm
See above in response to your first comment.
Monte
Oct 31 2023 at 4:23pm
We can debate whether or not IP has had limited success with respect to things like the New Deal, technology advancements owing to DARPA, and Operation WARP speed, but IP’s overall record has been disappointing, particularly in some of the poorest regions of the world.
Mactoul
Oct 30 2023 at 11:34pm
Large corporations are generally run for the benefit of their managers, see Burnhan’s Managerial Revolution. The situation is quite analogous to that obtaining in politics. A large diffuse majority (of shareholders or voters) and a concentrated power (managers or politicians).
Vivian Darkbloom
Oct 31 2023 at 10:24am
I assume that the article by Sowell comes from this source:
https://www.deseret.com/2007/1/25/19998051/thomas-sowell-why-do-corporate-executives-get-paid-so-much
First, Sowell provides zero support (logical or otherwise) for that assertion. Even if true, higher overall compensation doesn’t necessarily say anything about the size or composition of severances packages. Thirdly, why does he assume that “large investment firms” are spending *their own* money? Fourth, it’s pretty clear that individual shareholders of large publicly-traded companies don’t really determine how much a CEO will be paid, much less the compensation of the pay package.
https://www.blackrock.com/corporate/literature/whitepaper/policy-spotlight-executive-compensation-the-role-of-public-company-shareholders-april-2019.pdf
With such scant evidence Sowell provides in a blog post, why would that cause you to change your mind?
Vivian Darkbloom
Oct 31 2023 at 3:39pm
David,
While I think we agree that the US government should not be in the business of simply choosing winners and losers through an “industrial policy”, your article does not mention the issue of national security. Here, the question is not predicting which industries will or should do well, per se (although arguably it may fall under “should”), but which industrial capacity is essential to national security. Is the alternative to ensuring that there is an industrial capacity (steel, ship and aircraft building, aerospace, computer chips are a few that come to mind) that the government nationalize or create such capacity itself? Or, do you maintain there should be no exceptions and, if so, why?
Charley Hooper
Oct 31 2023 at 8:33pm
The Department of Defense has a huge budget. One objective of the expenditures made by the DoD could be ensuring the survival of key industries or companies.
Vivian Darkbloom
Nov 1 2023 at 4:37am
I’m sure you are correct. However, that fails to address my question. The point is that much Defense spending *is* part of a federal IP, particularly when that spending favors domestic producers. In fact, I suspect that much of the IP is actually due to underlying national security concerns. Whether these concerns are legitimate is, I think, open to debate on a case by case basis. Witness competing allegations of improper government subsidies to aerospace companies on both sides of the Atlantic.
And, the issue doesn’t stop with current DoD spending. National security also concerns anticipating future needs in the event of conflict. If you (and David) wish to argue that this is not a legitimate government concern, I’d be interested to hear your arguments.
Monte
Nov 1 2023 at 11:34am
Pardon the interruption, but EconLib’s Veronique de Rugy addressed this very issue in a recent post by pointing out that:
I won’t presume to speak for David, but I suspect he would agree. Rugy continues:
Therein lies the challenge.
Vivian Darkbloom
Nov 1 2023 at 11:46am
Thanks, Monte. I hadn’t seen that. But, great minds…
Charley Hooper
Oct 31 2023 at 8:29pm
Some politicians care only about getting re-elected. Any industrial policy they promote must help them (1) raise money and/or (2) attract votes.
Raising money helps them get re-elected. By helping certain industries, these politicians expect to see an increase in campaign contributions.
Some percentage of voters will have positive feelings toward an “industrial policy” and will vote for politicians who promote such a policy.
A politician might not know or care how or why an industrial policy will fail. If they are re-elected, that’s good enough for them.
vince
Nov 1 2023 at 2:03pm
Absolutely. And the solution is clear: get money out of politics. The problem is how to implement it!
vince
Oct 31 2023 at 9:54pm
Tying this with your earlier comment about back scratching, it wouldn’t surprise me if those large investment firms are choosing CEOs who will scratch their backs. Actually, it would surprise me if they didn’t.
Comments are closed.