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“Industrial Policy” Is the Hottest Idea in Economics. What Could Go Wrong?

President Biden is leaning toward using the government to support key industries in what’s sometimes referred to as “industrial policy.” However, a strong case could be made against it. WSJ chief economics commentator Grep Ip weighs in to help separate myth from reality.

Yellow globes, light bulbs, 11 October 2005. AFR Picture by JIM RICE Photo by Fairfax Media via Getty Images

Under President Biden, the U.S. is pivoting toward what some people call “industrial policy”—that is, using the government to support key industries, like green energy manufacturing and the manufacture of advanced computer chips. There is a strong case against industrial policy in economics: It’s the idea that governments do not know better than markets when it comes to picking winners, and industrial policy just wastes money and distorts the economy. But there’s another view, which is that industrial policy is utterly necessary to help the U.S. build an abundance of computer chips and green energy infrastructure. Greg Ip, the chief economics commentator at The Wall Street Journal, helps us separate fear from fact as we talk about industrial policy.

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In the following excerpt, Greg Ip discusses government interventions in the economy and the factors that have led to supply chain breakdowns.

Derek Thompson: So industrial policy has a bad reputation. Why?

Greg Ip: I think people intrinsically, when they hear that the government is going to be picking winners, they think, “Well, the government can’t do that better than the private market, can it?” And the mistakes that we’ve made with industrial policy tend to be remembered. Solyndra or supersonic transport or fast breeder reactors or syn crude, these were all boondoggles where the government spent a lot of money and didn’t have much to show for it.

I think the other reason is that the countries that were best known for pursuing industrial policy, like Japan and western Europe, they did very well up until around the ’90s, and their economy started to slow down. And the American economy, where we took a lighter touch, took off, and everybody envied Silicon Valley. And that history, I think, led the world in general to believe that maybe there was something to be said for the government just getting out of the way and letting the private sector do its thing.

Thompson: There’s something interesting about the idea that the success of Silicon Valley proved that the government should just get out of the way because, as I’m sure some people thought when you mentioned those things side by side, it was government investments in the Defense Department that helped to give birth to Silicon Valley. It was government investments that helped to lead to the takeoff of Tesla, which has created the richest man in the world. So would you agree that industrial policy, while it has a bad reputation—I think it’s true that it has, in many different pockets, a bad reputation—has also somewhat sneakily been a part of the American story for a lot longer than some people realize?

Ip: I definitely agree with that, that there is actually probably no advanced country that hasn’t done industrial policy in some way, shape, or form. The United States is no exception. As you probably know, Alexander Hamilton, our first Treasury secretary, was a big fan of industrial policy. He thought we should protect American manufacturers from British competition, either with tariffs or subsidies, until they were strong enough and competitive enough that they could survive on their own. So we were a high-tariff country for the first century of our existence. And as you note, the Pentagon and the space program have been big spenders on technology, whether it was semiconductor chips or lasers or spacecraft or jet engines, all of which eventually had extensive civilian applications. So there’s no pure free market economy here. There’s industrial policy everywhere, if you look hard enough.

Thompson: It still seems to be the case that industrial policy, at least as we think of it, fell out of fashion for a while, say, sometime between the 1970s and 1980s. Why do you think it seems to be having a resurgence in the Biden administration?

Ip: I think that the interest in industrial policy is part and parcel of a broader rethink of the free market globalization model that more or less held sway in the 1990s and the 2000s. While it’s true that the United States did much better than, say, Japan or western Europe for a lot of those decades, starting with the financial crisis of 2008, I think there’s been a lot of introspection about whether the world sort of steered too hard towards the total free market model. And then, at the same time, you just can’t ignore the fact that we’ve seen China, this economy, rise to such a prominent place of position and power, and there’s an economy where the government is involved at virtually every single level.

The People’s Republic of China lives and breathes industrial policy, always has—never really bought into the so-called neoliberal model of free trade. The fact that so many Chinese industries compete at the top level with Western industries reflects, to some extent, very interventionist behavior on the part of their government, whether it was subsidies and tariff protection or helping their industry steal the top technology secrets of their Western competitors.

Thompson: When we’re thinking about why this moment is happening now, you mentioned a couple really important culprits: the financial crisis, a reversion to neoliberalism, the rise of China. I want to add a couple other possible causes. One is inflation and inflation plus shortages. We have had in the news lots of stories about, oh, there aren’t enough computer chips, there isn’t enough baby formula, prices are rising as we’re seeing shortages either because of the pandemic or because of problems with international shipping.

And that, I think, has diverted a lot of attention in economics—especially among liberal economists and liberal economic thinkers—from the demand side of the equation, how do we give people enough cash to buy stuff, to the supply side of the equation, how do we create enough stuff so that if people have money to demand it, they actually can. The other, I think, is that Democrats have for a while been interested in passing some kind of green infrastructure bill, whether it was the Green New Deal or other versions of climate policy. And once they had something like universal control over the levers of legislative government, they saw an opportunity to enact those policies as well. Any other things to throw into the causal jambalaya here?

Ip: Yeah, I think you’ve mentioned two things. I think the supply chain breakdowns that accompanied the pandemic and the green energy transition, and I’m going to mention a third, which is COVID. And I think what all these three things have in common is they’re large systemic problems that are what we call in economics externalities. There’s no private actor that sees that as their responsibility of something to take care of. There’s no profit to be made essentially replacing fossil fuels with something else unless, you know, the appropriate incentives are put in place. The supply chain problems that we had coming out of the pandemic, if you think about it, they were a result of every company privately doing what was in its own best interest, which was to achieve the leanest, meanest supply chain possible with just a handful of suppliers and the lowest possible inventory.

And it was a system that, when everything worked well, was incredibly fast and efficient and cheap and enabled us to get amazing breadth of products with the click of a button very quickly, but was extremely fragile and bent under stress under all the distortions that the pandemic created. So I think if you take those three big events, the supply chain problems, COVID, and the green transition, they each present a plausible case for why the private sector cannot by itself solve the problem. And it creates at least a plausible opportunity, if not the actual correct response, but it creates at least a plausible case for why the government needs to get involved and not simply leave the solution to the private market.

This excerpt was edited for clarity. Listen to the rest of the episode here and follow the Plain English feed on Spotify.

Host: Derek Thompson
Guest: Greg Ip
Producer: Devon Manze

Subscribe: Spotify