Industrial policy: theory

Summary

This video explores the theoretical arguments for and against industrial policy, focusing on the role of government in supporting certain industries. It discusses key concepts like knowledge spillovers, coordination failures, and informational externalities, which argue that government intervention can help industries grow and overcome challenges. However, the video also highlights concerns about the knowledge problem and the potential for corruption and special interest influence. It concludes by examining practical considerations such as tariffs versus subsidies and the role of foreign direct investment, urging a balanced approach to industrial policy.

Takeaways

• 😀 Industrial policy refers to government efforts to subsidize specific industries and firms to aid in economic development.
• 😀 The first theoretical argument for industrial policy is based on knowledge spillovers and dynamic scale economies, suggesting that successful industries, like the automobile sector, can grow through government intervention and provide benefits to the broader economy.
• 😀 The infant industry argument is a historical theory that advocates for nurturing certain industries until they become competitive and self-sustaining.
• 😀 A second argument for industrial policy involves addressing coordination failures, where private sector entities may hesitate to invest due to lack of coordination, and government action can help stimulate growth in interconnected sectors.
• 😀 Informational externalities refer to situations where early movers in an industry bear most of the risk and cost of discovering its viability, while other potential firms hesitate to invest without first seeing success.
• 😀 A primary concern against industrial policy is the 'knowledge problem', where governments may not have the expertise to correctly identify which sectors or firms should receive support, leading to potential inefficiencies.
• 😀 Another criticism of industrial policy is the risk of corruption and political influence, where special interests may guide policy decisions, ultimately benefiting specific industries rather than the economy as a whole.
• 😀 The Mill test and Bastable test are criteria used to assess the success of industrial policy: the Mill test checks if a protected sector can survive in global competition without government support, while the Bastable test evaluates whether the long-term benefits of industrial policy outweigh short-term costs.
• 😀 A key distinction is made between tariffs and subsidies in industrial policy. Tariffs often protect domestic industries by restricting foreign competition, but subsidies may be more beneficial by reducing consumer costs and promoting innovation.
• 😀 Industrial policy doesn't always require tariffs or subsidies. Governments might also foster foreign direct investment by creating a favorable regulatory environment, legal protections, and tax incentives.

Q & A

What is industrial policy, and how is it generally defined?

Industrial policy refers to deliberate actions by governments to support specific industries or firms, often through subsidies, tariffs, or other regulations. The aim is to foster economic growth, develop certain sectors, and strategically help the economy evolve by choosing 'winners' and 'losers' in the process of economic development.

What are knowledge spillovers in the context of industrial policy?

Knowledge spillovers refer to the process by which the success of one industry, such as automobiles, can benefit other sectors of the economy by transferring knowledge, skills, technologies, and innovations. As an industry develops, the broader economy may become better at producing other goods or services.

What is the 'infant industry' argument for industrial policy?

The 'infant industry' argument suggests that emerging industries require government support to grow, much like infants need nurturing. By protecting and subsidizing these industries, governments can help them become competitive globally, eventually reducing the need for government support as the industry matures.

How do coordination failures support the case for industrial policy?

Coordination failures occur when multiple sectors or industries that need to develop together cannot do so because private actors hesitate to invest first. For example, an automobile industry might need a parts industry and a transportation network. Government intervention can help overcome these failures by coordinating investments and supporting the necessary infrastructure.

What are informational externalities, and how do they relate to industrial policy?

Informational externalities arise when a firm discovers valuable information about the success of an industry, but other firms hesitate to invest until they see proof of success. Government intervention can mitigate the risks of the first mover by subsidizing early-stage investments, encouraging other firms to follow.

What are the main arguments against industrial policy?

The two main arguments against industrial policy are the 'knowledge problem' and the risk of 'corruption and special interests.' The knowledge problem suggests that governments may not have the expertise to determine which sectors should be promoted, while the risk of corruption highlights the potential for industrial policy to be manipulated by political interests, benefiting specific groups rather than the economy as a whole.

What is the Mill test, and how does it evaluate industrial policy?

The Mill test evaluates whether a protected industry can survive in a competitive global market once government support is removed. If the industry cannot thrive without protection, the industrial policy may be considered ineffective or unsustainable.

What is the Bastable test, and how does it assess industrial policy?

The Bastable test requires that the long-term benefits of industrial policy outweigh the immediate costs of protectionism. It emphasizes that industrial policies should lead to net positive outcomes over time, balancing short-term costs with long-term benefits.

How do tariffs and subsidies differ in industrial policy?

Tariffs are taxes on imports that protect domestic industries by making foreign goods more expensive, while subsidies involve direct government payments or tax breaks to support domestic firms. While tariffs can harm consumers by raising prices, subsidies are often seen as a more effective way to support industries without distorting market prices.

What role can foreign direct investment (FDI) play in industrial policy?

Instead of focusing solely on tariffs or subsidies, governments may promote foreign direct investment (FDI) by creating a favorable regulatory environment, offering tax incentives, and ensuring the rule of law. FDI can bring capital, technology, and expertise into the economy without the drawbacks of traditional industrial protectionism.