One of my favorite book to have read (and to recommend to others to read) is How Asia Works, by Joe Studwell. I liked the book for many reasons, but here are the three main ones:
- It taught me that international trade textbooks are overrated
- It taught me that the practice of international trade is very different from the theory of international trade
- It helped me realize that when done properly, industrial policy is underrated
The trick, of course, is to understand fully what the phrase “when done properly” means. There are lots of excerpts from the book worth quoting in this regard, but I will restrict myself to just two:
“The state’s role is to keep money targeted at a development strategy that produces the fastest possible technological learning, and hence the promise of high future profits, rather than on short-term returns and individual consumption. This tends to pit the state against many businessmen, and also against consumers, who have shorter strategic horizons.”
“It investigates how Japan, Korea, Taiwan and China perfected ways to marry subsidies and protection for manufacturers – so as to nurture their development – with competition and ‘export discipline’, which forced them to sell their products internationally and thereby become globally competitive”
Defined in this fashion, industrial policy is not about raising employment, reducing inequality, reducing risk or mitigating the effects of climate change. It is, instead, about “producing the fastest possible technological learning”. And it is about nurturing the development of manufacturers with competition and export discipline.
(Note that India has tended to nurture the development of manufacturers by taking away competition and export discipline, and this remains mostly true even today)
As it turns out, industrial policy and how successful it is depends a lot on how one defines it, and what one wants from it.
The Economist has a Special Report in its latest edition, called “Homeland Economics”, which is its way of describing industrial policy. The six articles (and a video) that form this special report doesn’t define industrial policy in so many words, but the first article does define “homeland economics”:
Now, though, a radical alternative really is taking shape. Some call it “global resilience” or “economic statecraft”. We call it “homeland economics”. The crucial idea is to reduce risks to a country’s economy—those presented by the vagaries of markets, an unpredictable shock such as a pandemic, or the actions of a geopolitical opponent. Supporters say this will produce a world that is safer, fairer and greener. This special report will argue that it will, in large part, create the opposite.https://www.economist.com/special-report/2023/10/02/governments-across-the-world-are-discovering-homeland-economics
Homeland economics, it goes on to say, is a response to four big shocks:
- The economic crises of 2008 and 2020
- Geopolitical shocks (America and China going hammer and tongs at each other, plus Vladimir)
- Energy shocks (partly related to the second point, of course)
- Generative AI
And as the article goes on to say, homeland economics is about “protecting the world from similar shocks in the future”. It then describes what moves are afoot in the USA, in Europe, in India and elsewhere, and goes on to predict that these will mostly fail.
Why will it fail? Well, because the benefits will be lesser than the cost, simple:
The benefits of the new approach are at best uncertain. Meanwhile, attempts to break free economically from China are likely to be partial, at best. The benefits of green subsidies for the fight against climate change are also less clear than their proponents admit.The costs, by contrast, are clear. Research by the imf considers a hypothetical world which has split into America- and China-led blocs (with some countries remaining unaligned). In the short run, global output is 1% lower, and in the long run 2% lower. Other estimates put the global gdp impact at over 5%. It is as if the entire world decided to Brexit. The historical experience of industrial policy is not encouraging. Governments are going to waste a lot of money—not a good plan, given the demands from health care and pensions, and already-large deficits.https://www.economist.com/special-report/2023/10/02/governments-across-the-world-are-discovering-homeland-economics
The special report then goes on to make this point in more detail, and each of these articles are worth reading:
- Demand for Supplies (about supply chains and their resilience)
- State v Market (about how poverty will likely increase as a consequence of homeland economics)
- Missing the Point (about how inequality will increase)
- Second Best (about how green protectionism is unlikely to work out well)
- In Search of a Problem (about how economic stability will be lower)
So who is “wrong”? Is the book “How Asia Works” wrong, or is the special report by The Economist wrong?
Neither, if you ask me, and that is not me ducking out of having to give an answer. The reason both are not wrong is because both are answering the question “what are you optimizing for?” very differently. The Economist argues for economic efficiency being sacrificed at the altar of geo-strategy, economic security, self-reliance, the building of national champions in “strategic” industries, to encourage production at home, to limit the harmful impacts of climate change and to reduce inequality. How Asia Works optimizes for the fastest possible technological learning. If this increases inequality, results in molly-coddled domestic firms being shut down, or financial repression for households, well, so be it.
I do not know if the industrial policies being followed by many nations (including India) will “work” or not. I do not know if they are morally, ethically desirable. Nor do I know if they are the “best” set of policies. These are complicated questions, and like the rest of the planet, I have some ideas and opinions. But a lot of the confusion and debate, I suspect, will melt away by asking (and answering) a very simple question.
When it comes to industrial policy, what are you optimizing for?
Most countries today are not optimizing for economic efficiency. We can (and should) debate about whether this is a good idea or not. But if you tell them that they will fail from an economic efficiency viewpoint, they might well reply that this was the point!
To be fair to The Economist, they make a compelling case for why this is going to be a major problem (failing at economic efficiency). But most countries are likely to say that this is a price they think is worth paying in today’s day and age!
In all seriousness, I would love to read a Special Report from The Economist on whether economic efficiency is underrated or overrated.