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Work & Prosperity (Deep End)

Industrial policy is back on the agenda. In fact, it never really went away – in many western countries, the state has always intervened to promote certain favoured companies. Some of these, like Électricité de France, are state-owned, while others are supposedly private but have the status of ‘national champions’ (nudge-nudge, wink-wink). Either way, they get a lot of help from their respective national governments.

In free market Britain, we don’t really pick winners anymore – or, at least, we don’t favour individual companies if we can possibly help it. We do, however, favour particular industries, as demonstrated by the ‘light touch regulation’ (nudge-nudge, wink-wink) of the banking industry under the previous Labour government.

Obviously, in the case of the banks, this had disastrous consequences – but, regulatory screw-ups aside, is there anything inherently wrong with an industrial policy that concentrates on our national strengths? Writing for Project Syndicate, the economist Ricardo Hausmann argues that there most certainly is:

“Some ideas are intuitive. Others sound so obvious after they are expressed that it is hard to deny their truth…

“One such idea is the notion that cities, regions, and countries should specialize. Because they cannot be good at everything, they must concentrate on what they are best at – that is, on their comparative advantage. They should make a few things very well and exchange them for other goods that are made better elsewhere, thus exploiting the gains from trade.”

Specialisation works at the level of the individual or the company, but at the level of the local, regional or national economy the logic points in the other direction:

“When an idea is both intuitively true and actually false, it is often because it is true on one level but not on the level at which it is being applied. Yes, people do specialize, and they should specialize, too. Everyone benefits from each of us becoming good at different things and exchanging our knowhow with others. It is not efficient for a dentist and a lawyer, for example, to be the same person.

“But specialization at the individual level actually leads to diversification at a higher level. It is precisely because individuals and firms specialize that cities and countries diversify.”

Hausmann shows that the more diverse an economy, the greater the complexity (and value) of the goods and services it can produce. Diverse economies therefore tend to be richer economies:

“The Netherlands, Chile, and Cameroon have a similar population size, but the Netherlands is twice as rich as Chile, which is 10 times richer than Cameroon. Looking at their exports shows that the Netherlands is three times more diversified than Chile, which is three times more diversified than Cameroon.”

There are exceptions that prove the rule, of course – oil producing economies being the most obvious example. However, countries where wealth is based on a limited range of economic activities are often blighted by corruption, conflict and tyranny. This should come as no surprise – concentrations of economic power are more easily monopolised. Therefore, the wrong kind of industrial policy – one that acts against economic diversity – undermines democracy as well as prosperity.

Can there be such as thing as the right kind of industrial policy? Hausmann’s answer is yes, but only if it facilitates “the emergence of more winners” instead of picking winners. The best way to do this is to help individuals and businesses overcome the coordination challenges of a complex economy – i.e. by providing the infrastructure and the skills-base that enable new and profitable connections to be made.

In other words, the task of government is to bring people together without telling them what to do.

18 comments for: Industrial policy is back, but watch out for the bad ideas that come with it

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