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The Rebirth of Industrial Policy

Author: Michael Moran
Updated: December 19, 2008

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President Bush's decision to offer federal aid to troubled Detroit automakers (FT) has reopened an old debate about the wisdom or even the ability of the government to choose winners and losers in the American economy. Opposition in the U.S. Senate that killed a bill (WSJ) to do just that on December 11 shows strong doubts remain, though many say that is a bridge already crossed--the government made the decision in October to allow Lehman Brothers to fail while protecting firms like Morgan Stanley, AIG, and later Citigroup from collapse--many argue there is a difference between financial firms and U.S. industrial giants like Detroit's Big Three automakers.

Count Germany, Japan, South Korea, France, and other auto-producing nations among those making such a distinction. The World Trade Organization, fashioned in large part by the United States to guard against unfair trade practices, almost certainly will hear complaints about the bailout. The scope of the intervention in Detroit has the potential, according to Joe Guinan, a policy analyst at the German-Marshall Fund, "to be the torch that lights the fuse of a general resort to protectionism among America's trading partners and the beginning of a downward spiral that undermines the world trading system."

The European Union has threatened to prepare a WTO complaint (Bloomberg) if the terms of the U.S. auto bailout violate trade rules. European financial papers are filled with reminders of 2004, when the United States filed such a complaint on behalf of Boeing against European aircraft maker Airbus, which received generous subsidies from France. China and Japan, frequently accused of "dumping" below-cost products on the U.S. market to undercut American competitors, could take similar steps. This 2007 Council Special Report looks at the WTO's dispute resolution system in depth.

Back in the United States, the political arguments over saving the auto industry and the millions of people it employs mask a deeper question about industrial policy, a concept which never has found a comfortable place in U.S. political discourse. Free market advocates in both parties regard such an economic intervention as something akin to socialism, even if they do concede that in the current emergency, the role of the state in all industrial economies is on the upswing. Still, not since the 1984 presidential election, when Walter Mondale proposed a comprehensive industrial policy, has the issue sparked much discussion in either major U.S. political party. The reluctance to allow long-term governmental intervention persists, evidenced by the House GOP-led effort to torpedo the Troubled Assets Relief Program, or TARP, to bail out failing investment banks. "Binding the country to a tangle of socialist ideals will seal our fate as a second-rate economic power," wrote libertarian Peter Schiff, president of Euro Pacific Capital, in a Washington Post op-ed criticizing the bailout.

The U.S. system of government, with its strong state and local governments, decentralized economy, and powerful interest groups, has demonstrated its immunity to central planning. Even architects of the New Deal in the 1930s ultimately abandoned the idea they would choose winners and losers in the economy, fashioning instead for the Depression-era government the role of "Broker State," a mediator between the competing claims of different interest groups. Sebastian Mallaby, director of CFR's Center for Geoeconomic Studies, emphasizes that today's interventions don't necessarily discredit laissez-faire theory, rather just the particular mix that had evolved by the first decade of this century.

Many economists--even those preferring Chapter 11 to taxpayer-backed bailouts--will concede this last point: A de facto industrial policy has existed for decades in America, and in some sectors, like agriculture, government funding makes a mockery of market forces. Presidents of both parties have taken steps to protect and bail out key industries: Presidents Jimmy Carter, Ronald Reagan, Bill Clinton, and George W. Bush all took action to slow the decline of U.S. steel industry (NYT), and Carter extended loans to prevent Chrysler's bankruptcy in 1980. Government support for scientific research, defense, and aerospace contracting creates "winners" in those sectors. Working with Congress, the Pentagon has regularly extended weapons programs to preserve industrial capacity to build, say, nuclear missile submarines or aircraft carriers. (The Pentagon even has a deputy assistant secretary of defense for industrial policy).

So whether or not America is becoming "the United States of France," as TIME quipped after the TARP's approval, the ranks of those who regard federal spending as a tool to stabilize the economy have only swelled. N. Greg Mankiw, a free market advocate, Harvard economist, and chairman of the White House Council of Economic Advisors from 2003 to 2005, notes that in the current emergency, the most viable tools available to policymakers appear to be those devised by John Maynard Keynes, the British economist dismissed out of hand by many free marketeers as a relic of a bygone era. "His insights go a long way toward explaining the challenges we now confront," Mankiw writes in a New York Times op-ed.

President-elect Barack Obama, who supported the bailout, next plans to stimulate job growth with hundreds of billions of dollars in public works projects (NYT). Many economists support this idea. But others do not. CFR Senior Fellow Amity Shlaes warns that Japan's public-works stimulus in the 1990s may actually have been counterproductive. Alan Blinder, a Clinton-era White House economist, writes in this 2004 Princeton University paper (PDF) that such spending often takes too long to appear in the economy to make any difference. As ever in economics, the debate goes on.

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