Industrial Policy; B. Anderson

DURING the 1984 election season, In dustrial Policy became a catch phrase as candidates outlined their economic positions. Since the elec tions have now passed (at least for two quiet years), the phrase is not bounced around in the news columns as before, but advocates ofIndustrial Policy are as anxious as ever to see their ideas come to fruition. Thus, their ideas bear watching and those who see this particular policy initi ative as potentially disastrous to our economy should try to obtain what ever intellectual and political am munition is available to see that In dustrial Policy remains only an idea. Throughout this paper I shall be critiquing the so-called Industrial Policy ideas, but before I criticize I shall give the readers a general de scription of what these ideas are and how they would be implemented. First, it should be noted that InMr. Anderson is an economist in Chattanooga, Tennessee.

Bill Anderson Industrial Policy dustrial Policy advocates such as Harvard University's Robert Reich, Barry Bluestone of Boston College, Senator Gary Hart and business ex ecutive Lee lacocca see American in dustry in decline: our basic indus tries such as automobiles, steel, rubber and textiles are falling prey to subsidized or outright govern ment-owned foreign competition. The loss of such jobs, they contend, means the end of the American mid dle class as we have known it, and further erosion of the job base will relegate us to low-paying service jobs such as keyboard punching and hamburger flipping. America the once-powerful and wealthy will be come America the exploited colony. Second, advocates see Industrial Policy as fitting into a broader pic ture of "quality of life," which em phasizes things like health care, support services, paid vacations, en vironmental purity, welfare compen sation and other such amenities that 293 294 THE FREEMAN May "protect" us from the often harsh realities of life. Government plan ning and intervention, they argue, can help raise the standard of living for most, if not all, of us by providing more quality of life services.

Specific Industrial Policy imple mentations would include the following: (1) Increased government spend ing in health care, unemployment compensation, worker retraining, housing and relocation for displaced workers. (2) "Domestic Content" legisla tion for automobiles as well as in creased "protection" for other do mestic producers that must compete with foreign firms both in the U.S. market and abroad (included in this package would be a broad range of subsidies both for exporters and firms that sell mostly in this country). (3) Increased (or targeted) regula tion of U.S. firms, especially those in the transportation industry to in sure "stability" in the marketplace. (4) Reinstitution of the Hoover-era Reconstruction Finance Corporation that would make low-interest loans available to "threatened" U.S. firms. (5) Restrictions on plant closings to keep firms from shutting down unprofitable plans or enterprises in one area of the country and moving them to a more suitable business cli mate either in this country or in a foreign land.

(6) Expanding labor union power, giving "participatory rights" to wor kers in the decision-making of the firms where they are employed as well as providing workers' groups with low-cost liquid capital to enable them to buy plants that are closed or are being closed. (7) Targeting of potentially prof itable new firms (such as high-tech companies) by giving them "protec tion" as well as low-cost capital. Interventionism Of course, any observer of govern ment intervention into our economy can readily see that government has, at one time or another, followed the above scenario. Government expen ditures for health care and un employment benefits have steadily increased since the 1960s. Pro tectionism has been a part of Federal policy since the founding of our re public. The regulatory monster has expanded its reach for nearly a cen tury, and government support of unions has guaranteed organized la bor a far larger share of the work force than it would have if unions were forced to compete in the mar ketplace the way firms compete for workers.

But the advocates of Industrial Policy recognize this fact as well. They, too, admit that government al ready intervenes in the ways speci fied previously and further admit that intervention can even be harm1985 INDUSTRIAL POLICY 295 ful at times. The choice, they say, is not between intervention or non intervention; rather, we must choose between "smart" policy and "stu pid" policy.l Stupid industrial poli cies, the advocates say, disintegrate into a chaotic mixture of zero-sum clashes between competing sectors of the economy.2 Smart policy, they say, brings the different sectors to gether in a coordinated effort. The key, of course, is to know the differ ence between that which is "stupid" and that which is "smart," then have the political conviction and courage to see that Congress implements these policies. As Reich has noted: America has a choice: it can adapt itself to the new economic realities by altering its organization, or it can fail to adapt and continue its present decline. Adaptation will be difficult. . .. A new consensus is difficult to achieve when each person seeks to preserve his standard of living but finds that he can only do so at the expense of someone else. But failure to adapt will rend the social fabric irrepar ably. Adaptation is America's challenge.

It is America's next frontier. 3 Examples given by industrial pol icy advocates include the so-called success of the Japanese Trade Min istry, or MITI, and (if one can believe it) American farm policy. Both cases, the advocates write, show that by co ordinating private businessmen and government officials, an entire econ omy can benefit from new success and productivity. Most important, they say, is that the new efforts at Industrial Policy are not a case of the private sector versus the public sec tor, as is the case of socialism. Rather, they note, the key word is "coordination," or, perhaps, a "pub lic and private partnership." Partnership? To those who have become weary of the false battles of "public inter est" against the "private interest," such a proposed partnership might bring some relief. The truth is, how ever, this so-called "partnership" is every bit the assault on the private economy that has come with decades of socialist planning. At best, Indus trial Policy is a naive idea that will be rendered harmless by public in difference and its greatest sin will be that of wasting a valuable commod ity called paper. But at worst, In dustrial Policy will bring about large distortions and misallocation of cap ital in the economy while, at the same time, increasing the already intolerable mass grab for funds from the Federal treasury and push ing productive entrepreneurship underground.

Distorting the American economy is the last thing on the minds of the Industrial Policy promoters. After all, they say, the idea is to help, not hurt our economic prospects. One might ask, "How can anything so de structive come out of something meant to do so much good?"

296 THE FREEMAN May To refute the promoters' claims, then, we must show the ways in which such policy implementation will cause damage to the economy, as well as demonstrate the difficulty of putting such legislation in force. Before dealing with those subjects, however, we will first examine the two examples of success cited by pol icy proponents. Learningfrom Japan When viewed with a critical eye, the so-called magic ofMITI fades into political and economic reality. This is not to say that MITI has not had some success, but most likely those Japanese success stories would have occurred even if the bureaucrats in the trade ministry had not "tar geted" the semiconductor industry, among others. 4 What is more impor tant, however, is what MITI failed to accomplish-to the relief of the Jap anese. In the early to mid-1970s, MITI attempted to persuade Japa nese investors to target the steel and petrochemical industries rather than the automobile industry, which MITI declared could never be competitive with U.S. auto manufacturers on an international basis. As we know to day, Japanese steel stays alive mainly because of government sup port while the Japanese automobile industry has become the envy of the industrialized world. 5 No wonder, then, that Economist Katsuro Sakoh said that the recent economic success of Japan is "based not on how much it [the Japanese government] did for the economy, but on how much it restrained itselffrom doing."6 As seen by the recent wave of farm foreclosures-coming at a time when record supports are being paid to farmers-one is hard-pressed to com prehend the excitement Industrial Policy proponents have for farm programs. Yet, Economist Lester Thurow, an ardent supporter of in terventionism, has written, "In agriculture what started as a des perate effort to prop up a very large, sick industry in the 1930s ended as an industry that is the world's most efficient. There is no reason that feat cannot be duplicated elsewhere."7 In answering Thurow's glowing endorsement of farm policy, Richard McKenzie, an economist from Clem son University, comes directly to the point: What such advocates fail to report is that we have an agricultural policy that props up the price of food for the rich and poor alike, that adds to the impoverish ment of the lower-income groups in this and other countries, that contributes to the destruction of the soil base, and wastes a monumental amount of food all in the interests of appeasing a very powerful political interest group. 8 McKenzie touches on the point of interest groups made by Reich, but unlike Reich, he understands the na1985 INDUSTRIAL POLICY 297 ture of interest groups and is fully aware that appeasing such groups is not costless. For even if one ignores (and we will not do so in this paper) the economic illiteracy shown by In dustrial Policy advocates, it is im possible to bypass their political na ivete. Their fallacy is simply the fallacy of composition; that is, they forgot that what may be good for one special interest group is not neces sarily good for the public at large.

Farmers who receive supports from the federal government no doubt personally benefit, but the benefit is not shared by the public. Rather, thE~ public must pay for this transfer of wealth through higher taxes and higher food prices. To give such sup port to every sector of the American economy simultaneously is virtually impossible, since there would be no sector left to pIunder. Instead, such universal support would be an act of self-plunder, of everyone attempting to prosper at the expense of everyone else. Industrial Policy proponents to,· tally misread the true nature of gov,· ernment. In the view of those who believe government is the best tool to correct so-called "market fail· ures," according to economists Rob-· ert E. McCormick and Robert D. Tol· lison, "the state is a productive entity that produces public goods, in·· ternalizes social costs and benefits,. regulates decreasing cost industries (monopolies) effectively, redistrib·· utes income Pareto optimally (giv ing to some without hurting others), and so forth."9 A Flawed Theory But McCormick and Tollison, through their studies of govern ment, find that such an approach "is not a very believable theory of gov ernment action and, moreover, that it is flawed by the unwarranted as sumption that government can be called upon to correct imperfect mar kets in a perfect and costless man ner. That the state is not a perfect instrument for correcting market failures hardly needs demonstra tion. . .. Indeed, although imperfec tions in the economy may be la mentable, lamenting is the best that can be done if the consequence of government action is to decrease rather than improve economic welfare." 10 As stated earlier, Reich acknowl edges the impact of interest group behavior (called "rent seeking" in economic jargon), but then declares that Americans must "adapt" to "new economic realities," as though a few exhortations to unselfishness by (self-interested) politicians can change things. But the truth is, peo ple who have their hand firmly placed in the Federal cookie jar, along with those trying to jam their own hands into the chaos, will not suddenly turn altruistic because a few intellectuals write books. It must 298 THE FREEMAN May be remembered that the fallacy of composition works both ways. Most handouts to special interest groups constitute a small part of the Fed eral budget-that is, by themselves.

Particular groups asking for more Federal money, protection, or the like usually preface their requests with an acknowledgement that whatever portion comes to them will be only a minute part of the budget and that cutting out that giveaway will have almost no effect on efforts to balance the Federal budget. And, most importantly, such groups are firmly aware of the old adage that governments grow "because the benefits are concentrated and the costs are diffused." They argue, "See the good this program will do for us, yet the cost to the taxpayer is very minimal." Behavior at the Margin If the case is seen as being isolated from the rest of the budget, then the argument makes sense. But econom ics and the study of political and eco nomic behavior does not simply con centrate on total spending or total outlays. Rather, studies emphasize behavior at the margin. That is, when we look at the total budget pic ture, we view it as the sum of every little program (plus the gargantuan ones as well) that Congress slips into law. Anyone of those programs by itself constitutes only a small frac tion of total spending; added together, however, the programs be come part of a budget out of control.

Can such rent-seeking behavior be changed through exhortations by politicians and intellectuals? Hardly. If one views the present budget pic ture as the political norm, the pros pects for ending the interest-group giveaways are not bright. For one, neither intellectuals nor politicians are free of rent-seeking qualities. In the case of the politician, he or she is part of a barter system that trades favors for votes. Politicians are fond of asking for budget restraint-in someone else's district; they like to seek tax increases-far away from their constituents. Intellectuals, on the other hand, are not free of gov ernment largess themselves. Uni versities are perennial grant recip ients, as are particular professors who receive Federal monies for their own pet studies. And, finally, there is the issue of power. One can readily surmise that if the federal govern ment were ever to implement the version of Industrial Policy advo cated by the proponents, those in charge of overseeing the resulting programs would be the very intel lectuals who are interested in seeing the programs come to fruition.

Thus, one can be sure that the Ini tiation of a so-called comprehensive plan of Industrial Policy would not end the destructive rent seeking that presently characterizes our budget ary process. Instead, it would give 1985 INDUSTRIAL POLICY 299 government intervention a new re·· spectability at a time when the real· ities of intervention are proving just how harmful intervention and reg·· ulation has become. And as the po·· litical process would steadily worm. its way into the decision-making of the Industrial Policy czars, the fa cade of economic impartiality would crumble until nothing remained but rent seeking and interventionism. Economic Fallacies Plans of Industrial Policy can be criticized as in conflict with political reality. But those plans contain a multitude of economic sins as well" a mountain of errors which will be discussed next. The first challenge to the so-called need for Industrial Policy deals with the very claims that America is in.

the throes of deindustrialization. This challenge is vital because it at·, tacks what proponents see as the basic reason for implementing In·, dustrial Policy in the first place. While it is true that many of America's factories have shut down. in recent years, many on permanent shutdown since the 1981-82 reces sion, one must keep those facts in perspective. For one, much of the un employment in this country is con centrated in heavily unionized in dustries, including manufacturing and mining. (The construction in dustry-much of which is union ized-also suffers from high rates of unemployment, but high unemploy ment rates in that industry are com mon, due to a large number of eco nomic factors.) Because of the nature of unionism, such high unemploy ment rates are predictable, espe cially given the militancy of union leadership in this country. The higher-than-average wage of the union worker helps bring about un employment in two ways. First, as economic theory predicts, the high price of unionized workers forces the company to hire fewer employees than it ordinarily would have hired had market rates, rather than coerced wage rates, prevailed. Sec ond, the high wages make it attrac tive for other workers to seek union work, as well as making it attractive for laid-off union workers to remain unemployed until being recalled.

Thus, the high rates of unemploy ment in unionized sectors. But unionization has other nega tive effects on industry as well. Most of the recently closed plants were shut down because they lacked the needed capital to operate profitably. Unions have long been known to re sist recapitalization in plants be cause such retooling often leads to a smaller workforce in those particu lar factories, which equates to less membership in unions. Therefore, plant owners and managers have often had to limp along in a high technology age with yesterday's cap ital. While the economy was boom300 THE FREEMAN May ing, such problems could be masked; when the latest recession hit, how ever, the party was over and old, ob solete plants closed by the hundreds. No Mass Migration This is a grim picture, but does it translate into the claim by Indus trial Policy advocates that there is at present a mass transfer of jobs from the Northeast (snowbelt) to the South (sunbelt)? No doubt, some firms are relocating facilities from the Midwest and Northeast into the South. But the so-called massive transfer claimed by the Industrial Policy proponents just is not hap pening. Richard McKenzie points out that New England's manufacturing employment rate in the latter 1970s grew at a compound annual rate of 3.46 per cent, which was 50 per cent more than that of the South Atlantic region. This was no simple wealth transfer; rather, it reflected the growing high-tech boom and the ability of the New England states to provide such firms with a labor force that could match the job requirements.

In fact, according to U.S. Depart ment of Labor Statistics, projections show the distribution of manufac turing jobs in this country to remain relatively static through the rest of this decade. 11 While it is true that certain changes, some pleasant and some not, are occurring on the micro level of our economy, the broad picture is that the U .8. economy is strong. True, there is a small but sig nificant growth rate in the service economy, but this growth is a sign that we are becoming wealthier, not poorer as Industrial Policy propo nents tell us. This is because the growth of ser vices tells us that we need not em ploy huge numbers and proportions of our population in basic manufac turing jobs as was required in years past. The growth of fast food restau rants, for example, is not a threat to our well-being, but rather reflects the fact that Americans are eating out more, a sign of greater disposa ble income. The same can be said of numerous other service industries as well. Because our manufacturing base is efficient, and because low-cost foreign firms see this country as a strong market for selling their prod ucts, we are able to buy basic items at far less cost (in percentages of per sonal income) than could our fore bears. This means that we have money left over to eat out or pur chase services becoming more and more available to us. And as the po tential for service industries contin ues to grow, the opportunities for new kinds of employment grow as well.

Those who declare that the in crease in imports and the growth of service employment threaten our well-being forget that foreign firms will sell here as long as they believe 1985 INDUSTRIAL POLICY 301 they can receive something in re turn. Japanese auto manufacturers, for example, are not philanthropists; they do not sell us high-quality, in expensive automobiles out of altru ism. Rather, they seek goods and ser vices in return and if the day comes that we have no manufactures or if all of us are turning over hamburg ers at the local fast-food place, the Japanese or any other foreign pro ducer will look elsewhere for new markets (or the Japanese will undergo massive changes in their di etary habits-highly unlikely). The actual implementation of In dustrial Policy, judging from what has been described about the rent seeking aspects of the political pro cess, would be nearly impossible.

But, for the sake of argument, if it were actually put into law, could it succeed? That is, are opponents ac tually afraid that such an initiative could be more effective than free markets, thus discrediting a whole body of economic literature and its authors? If the writings of Nobel Laureate Friedrich A. Hayek are to be be lieved-and economic history has yet to discredit Hayek's work-the an swer is a flat no. First, and most im portant, Hayek has shown time and again that centralized planning can not replace the efficiency of the mar ketplace, and his writings have been proven by the unqualified market failures of socialist economies. The Role of Knowledge A recurring theme in Hayek's work is the role of know ledge in eco nomic processes, a theme recently emphasized by economists Israel Kirzner and Thomas Sowell.12 Hayek points out that while economic knowledge can be centralized in a few areas, it cannot be centralized when dealing with the entire work ings of an economy. As McKenzie notes: The mental capacity of our leaders is limited. They are capable of digesting only so much information intelligently.

Central control of the economy will ul timately be restricted by the mental lim itations of our elected and appointed leaders, even though they may be the "best and the brightest" among us. Growing complexity in products and pro ductive processes, which is forecast by in dustrial policy proponents, will necessar ily make us more, not less, dependent upon decentralized decision-making. This is because the growing complexity of pro duction means that our -leaders will be less capable of knowing and handling the entirety of the complex information that is known by others. IS No doubt the Industrial Policy ex perts are bright, intelligent persons. Few persons would deny that fact. However, the U.S. economy will not function better just because intelli gent, highly-educated men and women are trying to centralize eco nomic decisions. Rather, these deci sions are better left to those who, 302 THE FREEMAN May while lacking high-powered college degrees, are far more capable at un derstanding their own economic sur roundings than someone in Wash ington, D.C. As Sowell has noted, we need the skills of all persons in the economy, not just the skills of a cho sen few.14 Centralized knowledge simply cannot replace decentralized knowledge.

, Another serious flaw in the eco nomic reasoning of Industrial Policy advocates is their failure to under stand the problems of economic mal investment, a problem that has been analyzed by Austrian economists since the beginning of this century . . The outline of Industrial Policy calls for "targeting" growing or promis ing sectors of the economy with pro tection from foreign (and some do mestic) competition as well as making cheap capital available. It is this portion of the plan that makes malinvestment a virtual certainty. First, there is an inherent contra diction in the advocates' analysis. For a new industry to have promise, it must perform well in the market place, for the market is the only true bellwether for any product. If people do not see a use for a new product or service, if they believe that the new item cannot meet their present or fu ture needs, then that item has no fu ture in the marketplace. Because the market reflects the needs and wishes of large numbers of people, it is by far the best way to measure the promise of a product or service. No other method is comparable. Even if a government official declares an unpopular item to be a new member of the marketplace, there is no guar antee that the item will ever be used in large quantities if at all.

Therefore, the best that economic planners can do in determining the potential for a new product or ser vice is to make their determination after the fact. Their decision cannot precede the market's verdict; it can only follow. With that in mind, it is important to realize that the mar ket, and only the market, can truly pick winners and losers. For govern ment to do so can have disastrous re sults. Farm price supports, for ex ample, have made farming an attractive business for some inves tors because they were already guar anteed a price for their product-pro vided they could produce it. The lure of guaranteed prices has brought so many producers into the market that even government policies have not been able to keep prices at profitable levels. The result has been a 1930s sty Ie liquidation of the Farm Belt (made vividly clear by recent news reports). The same scenario would repeat it self anywhere the government tried to "target" what it p~rceives to be promising producers. The lure of easy capital and protection would entice new entrants into the market, and the resulting glut of production 1985 INDUSTRIAL POLICY 303 would bid input prices up and drag profits down. To put it hIuntly, if the U.S. government were to give the same kind of support to the semicon ductor industry as it presently gives to farmers, that industry would be flat on its back within a short time.

The policies of easy money and pro tection would bring about massive malinvestment of capital, a malin vestment that would sooner or later have to be liquidated when the mar ket would correct itself. Of course, malinvestment and liq uidation are impersonal terms. A human translation ofthem would in clude words like unemployment, job lessness, depression, and the like. For the price of malinvested capital must ultimately he paid by hu man beings, and it is the poor who suffer most. On a large scale, as both Hayek and Ludwig von Mises have pointed out, malinvestment ofcapital has led to every one of our recessions in this century, and the central culprit in each period of capital malinvest ment has been government policy, lJoth fiscal and monetary. The new Industrial Policy promises to be a re peat of former mistakes and a guar antee of more recessions. Thus, Industrial Policy is not a new promise of prosperity and a new age of American industry. Instead, it is simply, as McKenzie puts it, a hoax.

Granted, the deception is not delib erate, but it is deadly all the same. Government planning cannot sub stitute for the market at any time, even when one perceives problems of "market failure." The market will ultimately speak; it is up to us to be sure that the words it uses include prosperity and wealth instead of depression and unemployment. @) -FOOTNOTESlLester Thurow in Industrial Policy debate with Dr. William H. Peterson in Chattanooga, Tennessee, March 19, 1984. 2These ideas are put forth by Lester C. Thu row in his book The Zero-Sum Society, in which he sees government being pulled apart by com peting special interest groups. 3Robert Reich, The Next American Frontier (New York: Times Books, 1983), p. 21. 4Richard McKenzie, "The Great National In dustrial Policy Hoax," lecture given at Notre Dame University November 17, 1983, pp. 11-12. slbid., p. 12. 8Katsuro Sakoh, "Industrial Policy; The Super Myth of Japan's Super Success," Asian Studies Center Backgrounder, No.3 (July 13, 1982).

7Thurow, "Farms: A Policy Success," News week" May 16, 1983. 8McKenzie, p. 15. 9Robert E. McCormick and Robert D. Tolli son, Politicians, Legislation, and the Economy (Boston: Martinus Nijhoff Publishing, 1981), p.3. l°lbid., pp. 3-4. llMcKenzie, pp. 9-13. 12Both authors have made extensive use of Hayek's analysis on knowledge, Kirzner in Perception, Opportunity and Profit, and Sowell in Knowledge and Decisions. 13McKenzie,p. 15. 14ThomasSowell, Pink and Brown Peopleand other Controversial Essays, (Stanford: Hoover Institute, 1980).