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Industrial Policy: Self-inflicted Economic Damage

Here’s a letter to a new reader of Cafe Hayek:

Mr. Krawiec:

Thanks for your e-mail.

You wonder why I don’t share your “concern that China’s authoritarian model is out-perform[ing] ours at facilitating resource allocation to economically strategic sectors.” And you insist that this “great operational advantage” that the Chinese allegedly enjoy over us “is justification for our own government to respond in kind.”

With respect, I could not disagree more. Central direction of resources by the state has been tried again and again and has consistently failed even to come close to the success of market allocation of resources. This reality is true both for large-scale attempts at central direction, such as was tried in the former Soviet Union, and for the great number smaller-scale attempts, such as so-called “industrial policy” practiced in, for example, India and Japan.

Beijing might well artificially stimulate an industry or two in China, and these ‘successes’ will no doubt be trumpeted as ‘proving’ the superiority of state direction over the market. But in fact any such ‘success’ will come at the larger expense of the Chinese economy and people.

There’s simply no way that Pres. Xi or any of his mandarins can possibly know what are the industries for which the Chinese have, and will have, comparative advantages. The amount of relevant knowledge that can be gathered and processed centrally is minuscule compared to the amount of knowledge that individuals dispersed throughout markets learn and act sensibly upon each moment of the day. Unlike government officials, individuals in markets spend their own money, earn their own profits and suffer their own losses, have no political constituencies to satisfy, and are on the spot to notice the all-important details of both consumer demand and conditions of supply.

Yet I nevertheless agree that Americans will be harmed if Beijing continues to centralize economic decision-making. But we will be harmed in a way quite the opposite from what you and Pres. Trump imagine: We Americans will be harmed by Beijing’s industrial policy because that policy will weaken China’s ability to offer their exports to us at competitive prices.

If you and Trump insist on fearing that which we Americans should warmly welcome – namely, a growing and vibrant Chinese economy whose participants eagerly do business with Americans – then rather than worrying about Beijing’s use of industrial policy, you should encourage Beijing to ramp it up. If it does so, then Trump and others who believe that we Americans are harmed when the Chinese people become better able to export quality goods to us at attractive prices will be relieved to discover that Beijing’s practice of industrial policy steadily drains from most Chinese producers the ability to compete effectively in export markets.

Donald J. Boudreaux
Professor of Economics
Martha and Nelson Getchell Chair for the Study of Free Market Capitalism at the Mercatus Center
George Mason University
Fairfax, VA 22030