This post will combine two of my interests:
1. Framing effects
2. General equilibrium and the fallacy of composition
Although most Econlog readers can see past framing effects, they have a powerful effect on the general population. My claim is that most people would answer yes to the question in the title of this post. And I also claim they’d continue to answer yes if you reversed X and Y. It simply sounds good.
Do I have any evidence for this claim? Sam Bowman directed me to this tweet:
It’s all about the framing effects.
I’m reminded of this problem when I run across people advocating industrial policy. They tend to advocate policies that sound good, without fully considering the “general equilibrium” effects. The term ‘general equilibrium’ means that everything in the economic model is affected by everything else. For our purpose, just think of a simple downward sloping production possibilities frontier, with “industries of the future” on one axis and “older industries” on the other. Any industrial policy that encourages more of one has the effect of encouraging less of the other.
You might argue that both sectors can be boosted if you are in a recession. Yes, but that’s not industrial policy, that’s demand stimulus. True industrial policy is a set of taxes, subsidies and regulations that push economic activity toward some industries and away from others.
Consider a recent defense of industrial policy in the NYT:
Industrial Policy Isn’t Boring. It’s Big, and It Has United the Left and Right.
Many Republicans and Democrats agree: Governments should intervene to help the industries and technologies of the future.
That seems pretty clear, right? Julius Krein of American Affairs wants to use industrial policy to boost industries of the future, presumably areas such as biotech, AI, autonomous vehicles, fintech, virtual reality, etc.
One problem is figuring out which will be the industries of the future. When I was young, I had no idea that the booming industries of the 2010s would be yoga studios, pedicure establishments, tattoo parlors, massage parlors, SAT coaching, etc. One rarely saw that sort of business during the 1960s.
But here’s the bigger problem. The actual article Krein has written often seems to (implicitly) suggest the exact opposite, that we should be encouraging the industries of the past:
In the wake of the 2008 financial crisis, however, the Reagan-Bush-Clinton neoliberal consensus seems intellectually and politically bankrupt. Party “establishments” appear incapable of proposing, much less advancing, policies sufficient to address major economic challenges. . . .
In addition to improving competitiveness and productivity growth, industrial policy may be the only way to meaningfully increase economic opportunities for struggling regions and populations. More generally, during the last several decades, the benefits of productivity gains have mostly accrued to the largest capital holders. A successful industrial policy would aim to strengthen worker bargaining power while organizing and training a better skilled labor force. Industrial policy also involves, and even depends upon, rebuilding infrastructure. . . .
Just as Republicans and Democrats in the Bush-Clinton era had intense debates over issues like marginal tax rates, all the while advancing an underlying neoliberal agenda, so will future debates play out in an era of renewed industrial policy. Uniting both sides will be a desire to revitalize domestic industry and to use the state to ensure that the economy serves a broader set of stakeholders and public interests rather than only large shareholders.
What does that all mean? If we “revitalize” industry in some “struggling regions”, aren’t we likely to actually promote older industries? The popular story today is that we let the market allocate resources due to a misguided adherence to neoliberal ideology. As a result, we have booming high tech industries in Seattle, California and the Northeast, and a hollowing out of our older industrial sector in the Rustbelt.
I don’t know about you, but to me that looks like a policy that is very much oriented toward the industries of the future. We could adopt an industrial policy of propping up older industrial sectors and struggling regions of the country, but that policy would effectively discourage the industries of the future.
The upcoming reauthorization of the Small Business Administration offers a chance to make changes along these lines. Government agencies could also step in to seed investment funds focused on strategic industries and to incentivize commercial lending to key sectors, policies that have proven successful in other countries (including in Canada, Britain, Israel, South Korea, China, Taiwan and Singapore).
When you compare the US to poorer, less successful economies (which includes all countries on that list except Singapore), what stands out is that the US is completely dominant in the industries of the future. We have most of the world’s top high tech companies, most of the world’s top biotech companies, most of the world’s top research universities, etc. Germany and Japan are better at making cars, but we have Tesla.
If you want an “industrial policy” aimed at bringing America the industries of the future, I’d say we already have it. It’s called free market capitalism. If you want an industrial policy aimed at helping workers in struggling regions, workers displaced by competition from China, that would be the sort of industrial policy that European countries used to engage in during the bad old 1970s. Those policies help to explain why Silicon Valley is in San Jose, not in Oxford, Paris, or Dusseldorf.
Can’t we just help all sectors, industries of the past and the future? Not really. Economics is about making choices. If you help sector A, you discourage sector non-A. Think general equilibrium. Do we want to help or hinder industries like this?
I suppose you could try to thread the needle by promoting both high tech and struggling Rustbelt manufacturing and mining, but then what is being left out? Consider the following industrial policy:
1. We’ll spend lots of money subsidizing high tech industries that employ lots of nerdy young men.
2. We’ll also spend lots of money subsidizing older industries that employ lots of brawny male steelworkers and coal miners.
Yes, you could do both, and it might sound good, but what would that actually mean? Does that policy sound as good if you frame it this way:
“Let’s have an industrial policy that discourages the creation of businesses that traditionally employ women.”
To me, industrial policy is just a bunch of happy talk. It sounds good to encourage the industries of the future. It sounds good to help struggling workers in struggling regions of the country. But until industrial policy advocates make the hard choices, or even show they understand the choices that they are implicitly making, I’ll continue to assume there is no realistic alternative to neoliberalism.
I’m actually heartened by the fact that the policies proposed in the article (SBA? seriously?) are so weak and ineffectual. This suggests that Margaret Thatcher’s, “there is no alternative” is still in effect. Neoliberalism isn’t going away.
In fairness, Krein has written a more nuanced essay that what one might infer from the quotes I cherry picked. So I’ve been a bit unfair to him. He seems to want to boost manufacturing as a share of GDP, and have much of the new manufacturing occur in future oriented industries. But threading the needle that way is much harder than it looks, and real world industrial policies will either end up usefully correcting actual market failures (say with carbon taxes or basic research subsidies), or they’ll get distorted by the political process and end up stumbling over exactly the sort of dilemmas I discuss in this post. Who are we actually trying to help, the nerdy guys or the brawny guys?
And what about women?
READER COMMENTS
Benjamin Cole
Aug 20 2019 at 8:30pm
Obviously, a big topic.
One can say America is already strong in the industries of the future, but then it turns out those are the same industries that are heavily involved with government. Defense spending pours into aerospace and technology. The Department of Defense R&D budget is more than $100 billion a year (and was famously responsible for the invention of the internet). Advanced biology and the farm sector are heavily involved with the USDA. The NIH , FDA and federal funding of the entire health sector.
So, the picture gets muddy. America’s farmers are highly regarded, as is the technology applied in the agriculture sector. But would anybody define agriculture in the US as a free market? In fact, I think our government has the right attitude towards our farmers, in that they are highly regarded as productive members of our society.
In the Far East, governments exalt the producer.
Orthodox Western macroeconomists quote Frederic Bastiat and exalt the consumer.
If we could live a few centuries, we might see which system plays out better.
Iskander
Aug 20 2019 at 9:01pm
The funny thing is that historical romanticism was a reaction against the industrial revolution yet so many now hold romantic views about the virtues of manufacturing.
Scott Sumner
Aug 20 2019 at 9:14pm
Very good observation. Time does that sort of thing.
Matthias Goergens
Aug 21 2019 at 5:26am
Yes, time. But not only time, but also that we can now afford to run our manufacturing much cleaner. Gone are the smokestacks of the past, and the regular pea soup fogs.
nobody.really
Aug 21 2019 at 7:02am
On Prairie Home Companion, Garrison Keillor had a skit that simply involved him reading letters from people living in New York City during succeeding eras. Each letter decried how the city was clearly going to hell, with all this innovation driving out the traditional ways. But the punch line of each letter was that the accursed innovation of one era had become the beloved traditional ways of the next era.
This was such a delightful expression of creative destruction, and people’s lack of perspective thereon, that I’ve often searched for the text in the Prairie Home Companion archive. One of the innovations disparaged, and later prized, was pushcart vendors–so that should make the search easy, right? Still no luck. If anyone finds it, please advise.
Mark Z
Aug 21 2019 at 1:30am
What exactly is the ideal world for people who favor industrial policy to help ‘struggling regions?’ One where people virtually all stay in one place, never leave for a more prosperous region or city than the one in which one was born? Because that seems to be what’s implied by the assumption that, if a region is declining, “it” must be saved, even if that means making the actual people that make it up worse off by abridging their opportunities to work elsewhere. Cities rise and fall, it’s as natural as partnerships forming and dissolving. I don’t fathom what is so wrong with the idea that many people would be more productive somewhere other than where they were born by happenstance, and that’s a tragedy rather than a good thing when some of them act on that fact.
nobody.really
Aug 21 2019 at 7:25am
You are a persuasive writer. I am completely convinced that you don’t fathom this. Nor do many others. And thus was Trump elected.
For good or ill, some people have a commitment to a given locale. Often this commitment involves social networks in that location (sometimes known as “family” or “community”). True, the most upwardly mobile people in any given location might flee for greener pastures elsewhere, and many do, much to their benefit and the benefit of the GDP. But often to the detriment of those they leave behind.
We’ve had some occasional studies of wholesale movements of people. Stable yet poor communities living along Buffalo Creek had to be vacated as a result of a mining disaster–and those same people, now deracinated, fell into social chaos. In short, social networks are valuable things, even if they don’t fit well into an atomistic model of human behavior.
But on a simpler level, does it really make sense for the nation’s population to pour into California? If you don’t have the specialized skills demanded there, how would you pay the rent? (As Woodie Guthrie sang, “If you ain’t got the do-re-mi… you’d better go back to beautiful Texas, Oklahoma, Kansas, Georgia, Tennessee….”) So, to some extent, the romanticized “commitment to place” simply makes a virtue of the fact that many people lack a realistic alternative.
Scott Sumner
Aug 21 2019 at 8:13am
Seems like markets handle that problem quite well, as firms look for cheaper alternative places to invest when prices are high in a given area. Thus lots of firms move to Texas precisely because California is so expensive.
Thaomas
Aug 21 2019 at 8:05am
I think it makes sense to have an “industrial policy” or better said and “economic policy” that seeks to remove obstacles to growth and wealth creation. Nimby-ism and restrictive zoning in many cities is one. Since the benefits of research are not all captures by private sector researchers, generous support for basic and even some non “basic” research is warranted. Tariffs and other restrictions on trade should also go. Activities that produce externalities such as CO2 emission should be taxed. We should switch from a slightly progressive tax on income and a regressive tax on wages that goes toward the SS and Medicare trust fund, to a progressive tax on consumption set at levels to produce approximate zero deficit whe the economy is approximately at full employment (like now).
Scott Sumner
Aug 21 2019 at 8:14am
Thaomas, You said:
“I think it makes sense to have an “industrial policy” or better said and “economic policy” that seeks to remove obstacles to growth and wealth creation.”
It’s fine to favor those things, but that’s not what the term ‘industrial policy’ means.
Lysseas
Aug 23 2019 at 1:58am
However, some of the “successful” examples of “industrial policy” that Krein cites in one of the quoted parts may have been exactly this instead of more government intervention. I know from experience that in heavily regulated, inefficient economies, the government effort to help a sector very often consists not of a set of taxes and subsidies, but of letting the favored industry free of the struggling regulations.
Jon Murphy
Aug 21 2019 at 9:40am
In addition to the points you lay out above, one of the things about promoting “industries of the future” is that the future is always changing.
Let’s assume away the knowledge problem here, as well as the difficulty of knowing what the “industries of the future” are; let’s assume that said planner can know with absolute certainty what the industries of the future are at any given time.
Given absolute knowledge of the industries of the future, the planner (in accordance with an industrial policy) thus sets out appropriate controls to promote that industry at the expense of “obsolete” industries (tariffs, subsidies, tax breaks, things like that).*
As the industries of the future change (given changing present conditions), the central planner faces a new challenge: removing old controls and replacing them with new ones. These old controls have very real beneficiaries and their removal will cause very real harms. The beneficiaries of the old controls will likely fight tooth-and-nail to keep them in place; the removal of the protections will not, in the traditional sense, be cutting into extra-normal profit of the passe industries but rather into normal profits and push them into loss territory. As Gordon Tullock explained in his excellent 1975 paper The Transitional Gains Trap, firms and industries protected capitalize all the extra-normal profits they would obtain from their monopoly status and the subsequent successors only get a rate of profit normal to a competitive industry. The removal of such protections will inflict very real harms upon these industries and they will fight them. Since this process is not costless, real resources will be devoted to the propagation of the protections and thus divert resources from the promotion of the “industries of the future.”**
In short: knowledge is not the only uphill battle the central planner faces, but also the increased pressure when situations change. Thus, ineffective policies are likely to remain in place long after their usefulness has ended.
*Note that I am assuming as well that the planner realizes we exist in a world of scarcity and thus that trade-offs must be made, so then he tries to enact the trade-off that will be most in line with the spirit of the industrial policy.
**Note bene that this goal of some firms being discouraged is the goal of industrial policy. This does not change the fact that those formally protected firms will not likely go quietly into that good night.
Alan Goldhammer
Aug 21 2019 at 11:18am
We do have an industrial policy of sorts that is embedded in tax preferences. These are very inconsistent and can vanish via legislation or regulatory action. Good example here is the ethanol subsidy that benefits corn growing states which is now complicated because the Trump EPA is issuing waivers from the requirements like there is no tomorrow.
IMO, the one major role for government is in the funding of basic STEM research. It’s up to the capitalistic system to look at the commercial value of technology and then create industries/products. Trying to pick winners out of this is extremely complicated and that’s why we have more VC money than anywhere else. It’s up to them to figure out whether the prospective company is an Amgen or a Theranos (many other examples could be cited as comparators). Barry Ritholtz has a very good interview this week with Josh Wolfe on his Masters in Business podcast that covers these very points.
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