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Does Industrial Policy Suffer the Knowledge Problem?

Again, pardon the length.

Mr. M__:

Thanks for sharing with me GMU Econ alum Alex Salter’s recent Washington Examiner piece titled “Industrial policy is possible, which is why we should oppose it.”

I strongly agree with much that Alex so eloquently says there. But I disagree with him – and with you – that industrial policy of the sort called for by Oren Cass isn’t subject to the criticisms that Ludwig von Mises, F.A. Hayek, and other Austrian economists leveled against more comprehensive socialist planning.

It’s true that Oren’s explicit goals appear to be modest enough to be achievable – goals that include (in Alex’s words) “more factory workers and more of what factory workers produce.” And Alex correctly observes that “[d]irect subsidies, tax credits, and similar policies are fully capable of achieving this.” But Alex incorrectly claims that Oren’s case for industrial policy is thereby rendered immune to knowledge-problem criticisms.

While Oren and other advocates of his sort of industrial policy are willing (very generous of them!) to have Americans pay some cost to achieve these advocates’ desired outcome of more manufacturing jobs and fewer women in the work force, their case rests on the belief that most Americans will find this cost to be one worth paying. That is, Oren and those who sympathize with him believe that the economic outcomes that they propose to engineer will on net be better than the outcomes of freer markets – outcomes that Oren tellingly describes as being the results of the meanderings of a “drunk donkey” (meaning an economy that irrationally ignores the information offered by the compass held by wise planners).

And so when Oren writes – in words quoted by Alex – that his proposal “has nothing to do with the most efficient allocation of resources,” Oren reveals only his misunderstanding of what economists mean by “efficient allocation of resources.” Because “efficient allocation of resources” means ‘that allocation of resources that achieves maximum possible satisfaction of human wants,’ when Oren presses for his industrial policy he presses for a government-engineered allocation of resources that he believes will prove to be more efficient than is the allocation that would otherwise arise on a freer market.

This fact about Oren’s case alone means that Oren ignores the knowledge problem: How does he know that the number of increased American factory jobs that his scheme will achieve will be worth the cost? The fact is, he doesn’t know and he has no way of knowing.

But there’s a second way in which Oren’s proposal remains subject to the Austrian knowledge-problem criticism. Even if the greater number of factory jobs that industrial policy brings about tomorrow will be judged by Americans to be worth the sacrifice necessary to experience it, economic facts are always changing. Technology improves; tastes change; new sources of raw materials are discovered while some known sources surprisingly diminish; entrepreneurs develop new products and new methods of finance and distribution; some countries liberalize and enter the global economy while others militarize and pull back from the global economy.

In order to ensure that the government-engineered additional number of factory jobs remains at a level that is worthwhile for Americans to continue to pay for, the consequences of each and every one of these changes must be accounted for by industrial-policy mandarins. These mandarins must acquire this dispersed and detailed knowledge, process it, and alter their subsidies, tariffs, taxes, and other interventions accordingly in order to ensure that their engineered economic outcomes continue to yield net benefits to Americans. This knowledge-acquisition and processing activity must take place on a regular basis, with the subsidies, tariffs, taxes, and other interventions also changing regularly in light of knowledge of these ever-changing facts.

That industrial policy of the sort advocated by Oren Cass would not doom Americans to economic hell as quickly as would comprehensive socialist planning of the entire economy is indisputable. But it’s also indisputable that the same insurmountable knowledge problems that quickly doom to failure comprehensive socialist planning gradually doom to failure each and every form of industrial policy.

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

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