Can We Have a Rational Discussion on Industrial Policy?

“Industrial policy” is back in the headlines. Whether in the European Union, Germany, or the United States, there is an ongoing debate in the media, among politicians and economists about the future of the industrial sector. While some observers fear that governments implementing industrial policy (or interfering in the markets, as detractors might say) will cause a roll-back right into a GDR- or Soviet-style planned economy, others regard it as a panacea to counteract China’s state capitalism. Yet, why do industrial policy discussions cause such a stir?

Divided Opinions On Industrial Policy-making

What is industrial policy? Briefly defined,” industrial policy” refers to government initiated restructuring policies in favor of more dynamic activities. However, detractors consider that the state does not have enough information to fully understand underlying market forces. Moreover, they claim that targeted industrial policies would focus only on a few sectors unavoidably neglecting others. This may increase the risk of failed developments and the disruption of normal market competition.

But strategic industrial policies can be advantageous. Targeted industrial policies ensure, for instance, the development of basic technologies (e.g. the internet). These essential technologies would otherwise take longer to enter the market, as their outcome and return is too uncertain to awaken private investment interest. Moreover, policies targeted toward competitive sectors force companies to pursue productivity-improving innovation to become more competitive within the  sector. Hence, industrial policy can enhance rather than harm competition and innovation.

The Debate’s Common Denominator: Innovation and Protectionism

Although technological progress and innovation have always been a crucial goal of industrial policy, they have become the core of modern policy-making vis-à-vis the looming 4th industrial revolution, i.e. the digitization of the economy. It seems, however, that established players have taken their technology edge for granted and for quite some time overlooked (or even underestimated) the “catching-up” of emerging economies. The dynamics of the global economy have drastically changed over the past 20 years. Emerging markets have grown rapidly, and China especially is on the verge of becoming a serious competitor to established industrialized countries. China is the reason why industrial policy is back on the table.

The last decade has shown that competition with China might not always take place on equal footing due to strong government involvement in its economic development. In its industrial policy strategy “Made in China 2025” (Zhongguo Zhizao 2025), the Chinese government made clear its ambition to transform the country into a global leader in high-tech products and services.
China is supposed to leave behind its role as the “factory of the world (shijie gongchang)” and become the face of the 4th industrial revolution by 2049. Organized in ten key industries, this strategic plan seeks to make China the world’s leading manufacturer of telecommunications equipment, railways and electrical power supply, as well as at least the second or third largest manufacturer of robotics, automation technologies and electrical vehicles. If China achieves this goal, countries like Germany and/or the United States would lose significant market share in many of these industries. This would not only have an isolated effect on the companies in these sectors but could also represent a threat to national economies as it would lack competitiveness in industries that are key to future production processes and business cycles.

Different Countries, Different Approaches

The United States on the one hand is reverting to protectionist measures like tariffs, especially but not only directed at China, thus driving the world towards the brink of a full-fledged trade war and breaking the U.S. away as a reliable pillar of the international economic order. As a result of these tensions, the relationship between the United States and China has quickly deteriorated. As is typical, protectionist measures have led to mirrored protectionist reactions and make mutual relations based on diplomacy and negotiations virtually impossible. The United States’ approach might help the country in the short run but might do much more harm than good from a long-term perspective.

Germany with its newly drafted “National Industrial Strategy 2030” on the other hand is about to abandon its reluctance towards a more active role of the state in the economy and take an “industrial policy” approach. Together with France, it issued a “Franco-German manifesto for a European industrial policy fit for the 21st Century”, which – similar to the German version – puts a strong focus on strengthening indigenous innovation and adapting existing framework conditions. Protection of industries plays a role, too, but does not appear to be the first means of choice. Moreover, both approaches include a more long-term (i.e. 10 years) perspective, which goes beyond the sometimes-short-term oriented approach to policy-making bound by election terms.

Rethinking Existing Notions of Industrial Policy

In the current debate on these recent advances towards strengthening industrial policy, quite a few reactions have been reflexive and seem to be influenced by experiences of the past, dating back to the Cold War. However, in times of major global disruptions, such as a rapidly changing international order and a gradually progressing 4th industrial revolution, it is important to have an open and unemotional discussion about coping strategies, including those that were frowned upon in the past.

Today the European Union and Germany face a powerful player in China that thinks as far ahead as 2049. This makes it key for Germany and the European Union to take a long-term perspective themselves, as is to some degree already embedded in the current industrial policy drafts. It also makes sense to strive for a common European approach, since this is the only means to play alongside China and the United States as an international heavyweight.

A smart industrial policy that is beyond traditional notions of (failed) industrial policies could indeed be a solution to some of the current and future challenges. It certainly will not be a panacea, but it also has nothing to do with a race back into a planned economy. The idea of taking a contemporary approach to industrial policy should therefore not be discredited from the very beginning. The debate should now rather focus on what specifically a smart industrial policy could look like, while at the same time being open for alternative policy approaches.

If you liked this post feel free to also take a look at our Globalization Report 2018.