I'll consider the theories behind industrial policy,
but keep in mind, there's also a video on the evidence about industrial policy.
People use the term industrial policy to mean a lot of different things.
But for our purposes, just think of it as
deliberate attempts by governments to subsidize particular industries and firms
and pick winners and losers in the process of economic development.
The first theoretical argument for industrial policy
relates to what are sometimes called
knowledge spillovers and dynamic scale economies.
What does this mean more concretely?
Consider an automobile industry.
If a country has a successful automobile industry,
this may require that industry to be a certain size or scale.
And in this argument, the government, by some mix of tariffs and/or subsidies,
can help the automobile industry grow to that size or scale.
There's also the possibility that having a successful automobile industry
brings knowledge spillovers for the rest of your economy.
For instance, as an economy develops a successful manufacturing capacity,
this may, in the longer run,
help the economy get good at making other and different things.
A version of this argument is quite old, and it was discussed extensively,
at least as early as the 19th century,
and then it was called the infant industry argument.
The claim there is that certain industries are in a sense like infants.
They need to be fed, they need to be coddled,
they need to be helped,
and eventually they will grow up and be strong and healthy.
A second argument for industrial policy
has to do with what are sometimes called coordination failures.
So, again, let's go back to our example of the automobile industry.
It could be that, to have a successful automobile industry,
your country also needs an auto parts industry.
Your country may also need an extensive rail network
to ship the parts from where the parts are made
to the automobile production plants and so on.
But it could be, possibly, that maybe no single private sector individual
will move first and build his part of the network
because he sees that the other individuals are not investing.
So, in this argument, there's at least potentially a role for the government
to have a kind of big push or big move forward
and get everyone on board with the idea that a particular sector is going to grow,
and, thus, to help overcome these potential coordination failures.
A third theoretical argument has to do with what are called
informational externalities.
Again, consider the automobile industry and imagine a developing nation
which might have two or three potential automobile producers.
Maybe the producer who goes first, is the one who discovers
whether or not automobile production can be successful in that country,
but of course the one who moves first also bears most of the risk.
So, the one who would move first, discovers information
for a number of different producers.
But you could imagine a situation where each potential producer is afraid
to move first and waits for someone else to take that plunge.
Arguably, some kind of coordinating policy or subsidy
might help overcome this problem and help get the nation onto a path
where it has a successful automobile industry.
Two of the major theoretical arguments against industrial policy;
they're fairly straightforward but they're also fairly powerful.
The first we can call the knowledge problem.
Do individuals in a government actually know
which are the economic sectors or firms which should be encouraged?
After all, these are bureaucrats
and they're not necessarily in the best position to judge
what will be a successful entrepreneurial venture.
There are plenty of examples
where governments have tried to encourage particular sectors.
Those sectors turned out to be failures
and it was a mistake in the first place that the government was to think
that it was the one to know which sectors really should be advanced.
The second argument asks the simple question:
Will special interests corrupt industrial policy?
So, keep in mind industrial policy is not generally
some kind of objective fact-finding exercise
run by perfectly honest angels in the public interest.
Industrial policy is run by real, imperfect, self-interested
and sometimes corrupt human beings.
And those human beings respond to political incentives,
they may be caught up in a framework of autocracy,
they may be catering to special interests,
and, very often, industrial policy will be run in the interests of
particular corporations or industrial sectors
rather than the nation as a whole.
If we're talking about problems with industrial policy,
there are also two particular tests to keep in mind.
They're called the Mill test and the Bastable test.
The Mill test requires that a protected sector
eventually can survive in a pretty tough world of global competition
once government protection is taken away.
The Bastable test requires that,
industrial policy; it may involve some costs now,
in the form of industrial protection,
but over time the benefits for what you're doing
have to outweigh those current costs.
For industrial policy to be a good idea,
it actually has to pass, usually, both the Mill test and the Bastable test.
At the theoretical level, two other questions to keep in mind.
The first is tariffs versus subsidies.
In practice, a lot of industrial policy consists of tariffs.
Tariffs keep out foreign goods and they protect domestic firms.
But the logic of a lot of industrial policy theory arguments
actually implies subsidies would be a better idea.
But what we get in practice, very often, is tariffs rather than subsidies.
And tariffs very often are worse for domestic consumers
than subsidies would be.
The second question is that even if you've decided
that some kind of industrial policy should be done,
it doesn't have to mean either tariffs or subsidies.
It could be that the real policy which is called for,
is some kind of promotion of foreign direct investment,
and that could be through the rule of law,
it could be through a favorable regulatory environment,
it could be through a low tax regime.
So, the arguments for industrial policy taken alone,
do not themselves decide that you would prefer tariffs or subsidies
over just having more foreign direct investment.
This is a complex topic with a lot of different angles,
and I would stress that this video has only covered a few.
For further reading,
I would suggest starting with the two pieces listed on this slide.
But keep in mind that really quite a few of our other videos
very directly bear on this question.
And if you view the other videos on economic growth,
the section on trade,
any talk of increasing returns,
and also some of the videos in the history of thought section,
you'll get a deeper and more detailed look at this question of:
What are the theoretical arguments for industrial policy?