Industrial policy is not the monster under your economic bed!

Industrial policy, often vilified as a harbinger of inefficiency and protectionism, is not the demon it is made out to be, especially for developing nations like India

By Aditya Sinha

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Published: Sun 24 Mar 2024, 10:21 PM

In the film "The Big Short," based on the true story of the 2008 financial crisis, a character named Mark Baum, played by Steve Carell, epitomises the act of criticizing just for the sake of it. He is constantly on the lookout for flaws in the financial system, often ignoring the broader context or the underlying factors that contribute to those flaws. His character shows that criticism, while necessary, can sometimes overshadow the complexities of a situation, leading to a partial or skewed understanding. This tendency to focus on the negative aspects, often disregarding the nuanced realities, can lead to an incomplete critique of any policy or system.

This brings to mind the critique by economist Raghuram Rajan in his recent piece for the Financial Times, where he argues against protectionism and industrial policy, stating that governments are not good at picking winners and that such policies are inherently flawed. While Rajan raises valid concerns, his argument can be seen as oversimplifying the issue. It doesn't fully account for the geopolitical complexities that often drive protectionism and the strategic considerations that countries must weigh. Just as in "The Big Short," where Baum's relentless criticism misses some of the broader economic narratives, Rajan's critique, though insightful, may overlook the finer details and ramifications of industrial policies in the geopolitical arena.

Rajan argues that instead of improving globalization by rectifying past errors, many elites are imposing conditions that lead to overt protectionism. This is exemplified by the US's approach to national security, where measures initially intended to protect critical technologies have broadened to the extent that they now justify banning a wide range of information-collecting devices and platforms on security grounds, affecting companies like TikTok in the US.

Not many have read a paper by John Maynard Keynes which he wrote in 1933, titled “National Self Sufficiency”. Keynes, originally a staunch advocate of free trade, experienced a significant shift in his economic thinking, leading to what is often referred to as a "U-turn." He grew up valuing free trade as not only an economic principle but also a moral imperative. However, by the mid-20th century, Keynes acknowledged a change in his perspective, attributing it to the altered hopes, fears, and preoccupations of his generation, influenced by the changing world conditions, particularly the Great Depression. This shift led him to reconsider the role of government intervention in the economy, moving away from his earlier free trade convictions to a type of self-sufficiency which could combat unemployment and stimulate economic growth.

He points out several reasons for this change of heart, including concerns that economic interdependence may not ensure peace and could lead to economic imperialism, a desire for economic autonomy to avoid the influence of foreign economic fluctuations, apprehensions about the negative impacts of foreign investment, and the belief that advancements in technology and industrialization reduce the need for international specialization. Additionally, there's a shift in values towards prioritizing national interests and social goals, a trend of countries experimenting with various politico-economic systems to suit their unique contexts, a pursuit of economic resilience against global uncertainties, and a critique of international capitalist models perceived as inequitable and unsustainable.

Regardless, apart from this Keynesian critique, there are other reasons critiques too.Firstly, the comparison between advocating for a better globalization and the actions of the elite implies that the two are mutually exclusive, which is not necessarily the case. National security concerns can coexist with the pursuit of improved global integration. For example, while the US has taken steps to restrict certain foreign technologies like TikTok due to security concerns, it continues engaging in international trade and global cooperation in other areas.

The COVID-19 pandemic highlighted the vulnerabilities in global supply chains, particularly in semiconductor manufacturing, which is essential for a wide range of technologies, from mobile phones and AI chips to missile defense systems. This situation underscored that having a robust domestic manufacturing capability for such critical components is not just a matter of national pride but a crucial necessity in today's digital era, as it directly impacts national security.

Secondly, Rajan's argument presumes that the protectionist actions taken by governments such as the US and India are primarily protectionist rather than genuinely security-driven. While there can be an overlap between security measures and protectionist outcomes, this does not inherently mean that the primary motivation is economic protectionism. For instance, the bans on specific Chinese and American technologies in respective countries are often based on extensive intelligence assessments and concerns about data privacy, espionage, and national security, not merely on the desire to protect domestic industries.

Thirdly, Rajan’s argument does not account for international relations and trade's dynamic and reactive nature. When one country imposes restrictions, it often leads to retaliatory measures, creating a cycle that can appear protectionistic. However, these actions are sometimes strategic moves in broader geopolitical negotiations rather than straightforward attempts to undermine globalization.

Later in his piece, Rajan demonizes industrial policy and calls it a “new elite project” for “creating national champions”. Again, there are issues with this argument. Dani Rodrik has extensively argued that industrial policy is not merely about government picking winners but about creating a collaborative environment where the private sector and government work together to foster innovation and industrial development. According to Rodrik, successful industrial policy involves the government acting as a facilitator, helping to correct market failures, investing in public goods like education and infrastructure, and supporting sectors with significant growth and technological advancement potential.

Mariana Mazzucato extends this argument by emphasizing the state's role in driving innovation and economic growth. In her book "The Entrepreneurial State," Mazzucato argues that many of the most innovative and technologically advanced sectors have benefited significantly from proactive government policies and investments. She contends that the state can play an entrepreneurial role, not just fixing market failures but actively shaping and creating markets, thus leading to sustainable economic growth and development.

Rajan’s argument against industrial policy in the chip sector, citing the inefficiency of bringing the entire supply chain domestically and the potential for a global glut, overlooks the strategic importance of this sector. Chip manufacturing is not just about economic gains but also about national security, technological sovereignty, and global competitiveness. The case of Russia managing without a domestic chip industry under sanctions does not necessarily argue against developing such an industry; rather, it highlights the strategic vulnerabilities that come with dependency on foreign technology.

Moreover, the slowdown in cross-border investment and the projection of lower growth rates in emerging markets underscore the need for proactive industrial policies. These policies can stimulate innovation, build domestic capabilities, and reduce dependency on volatile global markets.

Industrial policy, often vilified as a harbinger of inefficiency and protectionism, is not the demon it is made out to be, especially for developing nations like India. Critics like Raghuram Rajan caution against government intervention in markets, emphasizing the risks of protectionism and the inefficiencies of trying to pick winners. However, this view, while valid in its scepticism, overlooks the nuanced role that well-crafted industrial policies can play in fostering economic growth, technological innovation, and national security. India’s production-linked incentive scheme is one such example of industrial policy, which is not simply creating national champions, but rather, it is attracting the best players from the world to come and manufacture in India. Apple is one such example. Clearly, industrial policy is not the economic bogeyman it's made out to be; it's more like the friendly ghost helping to tidy up the economic house!

Aditya Sinha (X: @adityasinha004) is Officer on Special Duty, Research, Economic Advisory Council to the Prime Minister of India. Views personal.

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