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In late 1983, when I was in my second year as a senior economist with President Reagan’s Council of Economic Advisers, I was tasked with writing the chapter on “industrial policy.” Industrial policy was all the rage back then. Various politicians, especially Democratic ones, advocated the idea. Among them was former vice president Walter Mondale, who seemed to have the best odds of winning the Democratic nomination for president and who, in fact, did win the nomination. So we knew it was a hot issue and my two bosses, chairman Martin Feldstein and member William Niskanen, decided that we should devote a whole chapter to the issue.
The essence of industrial policy is that government officials, looking ahead, predict which industries will or should do well, and then use various policy instruments—tax policy, subsidies, subsidized loans, and regulation—to move the economy in what they think is the best direction. They are, in Adam Smith’s words, updated, “men and women of system.”
There are two problems with industrial policy: information and incentives. Government officials don’t have, and can’t have, the information they need to carry out an industrial policy that creates benefits that exceed costs. Also, they don’t have the right incentives. If they spend literally billions of dollars of government revenue on buttressing an industry and the industry fails, they don’t suffer any personal wealth loss and don’t even lose their jobs. The only cost to them as individuals is their prorated share of tax revenues, which will typically be no more than a few hundred dollars. So what ends up happening is that subsidies and preferential treatment are given to the politically powerful, which reduces the amount of capital available for unsubsidized entrepreneurs and innovators.
This is from David R. Henderson, “Why Industrial Policy Fails,” Defining Ideas, October 26, 2023.
Read the whole thing.
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