A monster from the past

The global turn to industrial policy defies history and logic

Over the past few years, a monster long thought vanquished has once again reared its ugly head: Industrial policy. The notion that a government can play favourites across the various sectors of the economy has never of course gone completely out of style. What matters is the scale of this intervention, its purpose, and its chosen instruments. On each of these, there has been a reversion to past levels, which is deeply disturbing for anyone with even a rudimentary knowledge of economic history. It is particularly troubling when industrial policy spills over into trade policy and causes the erection of anti-competitive walls of one kind or another.

For Indians to imagine that our state is capable of conducting an effective industrial policy is particularly puzzling. I know we are a young people, but surely in a country of 1.3 billion people there are enough voices around that remember what a mess the government has made in the past when it tries to pick winners? It is all very well to do this at the boutique level — ensuring that two or three sectors of strategic or national-security importance are well-funded and have locally dominated supply chains. But when such thinking begins to percolate across sectors and infects even such supply chains as refrigeration or toys, then one has to wonder whether everyone making policy was born after 1991.
 

India is not the only country where such industrial policy is enjoying a renaissance. In the most recent issue of Foreign Policy magazine, Adam Posen — the president of the Peterson Institute for International Economics in Washington, DC — has written a lengthy indictment of the current administration in the United States for what he calls “short-sighted self-dealing”. This is a country, after all, that under two successive administrations from two different parties has failed to drop its obstructive approach at the World Trade Organization; has introduced multiple targeted tariffs and competitive subsidies; has openly tried to influence commercial decisions as to location and relocation of supply chains; and has introduced subsidies for infrastructure and “frontier” technology sectors on a previously unimaginable scale. Dr Posen argues that “(this) policy approach, while having considerable popular appeal at home, is based on four profound analytic fallacies: That self-dealing is smart; that self-sufficiency is attainable; that more subsidies are better; and that local production is what matters. Each of these assumptions is contradicted by more than two centuries of well-researched history of foreign economic policies and their effects. Neither the real but exaggerated threat from China nor the seeming differences of today’s technology from past innovations change underlying realities”.
 

The argument in Dr Posen’s essay focuses in part on the unique benefits that have accrued to the United States from its special role as referee and supporter of the multilateral system. Yet many of his points are equally applicable to economic blocs that have received few such benefits, in spite of wealth and size, such as the European Union. Or, indeed, to less affluent economies that hope to grow rich over time, such as India. The essential point is that the true benefits to a country flow from increasing productivity of its workforce; and that increasing productivity comes from the widespread domestic adoption of frontier technology, not from localising its production. Indeed, focusing efforts on controlling the production of productivity-enhancing technologies could slow down adoption by raising costs — and therefore have a major negative long-term effect on growth.
 

A concrete example of this dilemma in India has been the approach to photovoltaic units, or solar panels. The government was divided internally for some time on whether it should import as many panels as possible in order to speed up their use and adoption and thus decarbonise electricity and increase access in the most remote areas; or whether it should instead erect tariff and non-tariff walls while prioritising domestic manufacturing in order to control the solar supply chain. In the end, it has chosen the second route with predictable negative effects on adoption, efficiency, access, and decarbonisation. The fear is that China will monopolise the supply chain. Yet this argument is made without a clear model of how hard it will be to break such a monopoly if required. We are not talking here about advanced semiconductors or rare earths; could Beijing ever effectively and sustainably blackmail a large country with an advanced industrial base by threatening to disrupt the availability of solar panels? As many have pointed out, the Russian blackmail of Europe over gas supplies did not work. Solar-panel manufacturing is far easier to substitute for domestically than natural gas pipelines. So the national-security argument hardly works. Meanwhile, if the Chinese government is pouring its revenue into making solar panels cheaper, what is the coherent argument against India reaping the benefit of those subsidies?

Illustration: Ajay Mohanty

The major “like-minded” economies, from Japan to the European Union to the United States to India, have all to one extent or another been spooked by the Chinese threat and the lopsided nature of China-centric supply chains into one form or another of industrial policy. The threat might be real, but the response needs greater thought. A measure meant to target unfair Chinese practices should target those practices specifically, not all foreign trade or free commercial choice. And even then we should be very sure that we are not, in the long run, hurting our own economic prospects by introducing the measure.
 

Dr Posen’s recommendations for the US are the following: First, it should “post a narrow list of militarily important technologies that should not be exported to China and that the United States should not be solely dependent on Chinese production for”. And second, to “coordinate, not compete”, with like-minded countries on public investment. These are both reasonable principles for Indian policy makers also to adopt. The aim should be to spend Indian public money wisely, to ensure no high-cost economy emerges, and to incentivise the quickest possible adoption and spread of productivity-enhancing technology. For the US the stakes to misunderstanding the usefulness of industrial policy are merely the loss of leadership in the tech race to a strategic competitor. But for India the stakes are immeasurably higher. We cannot go back to policies that failed us for decades at a time when we need to be growing faster than ever. A turn to protectionist, self-obsessed industrial policy risks keeping us poor for another few generations.

The writer is head of the Economy and Growth Programme at the Observer Research Foundation, New Delhi