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Industrial Policy Does Indeed Fall Victim to the Knowledge Problem

In my latest column for AIER I argue that the knowledge problem, as identified long ago by Ludwig von Mises and F.A. Hayek in their demonstrations that socialism cannot work as advertised, also fatally afflicts industrial policy. A slice:

The fact that some national conservatives deny that their goal is economic efficiency reveals only that they fail to grasp economists’ meaning of efficiency. Were they to grasp this meaning they’d understand that “efficient allocation of resources” means ‘that allocation of resources that achieves the maximum possible satisfaction of human wants.’

And so [Alex] Salter is correct when he observes, about the increased factory work and more factory output demanded by national conservatives, that “[d]irect subsidies, tax credits, and similar policies are fully capable of achieving this.” But he’s incorrect to suppose that the story ends there. The story ends only when we determine if these engineered increases in factory work and output are indeed worth their costs, for only if this juicing-up of the manufacturing sector is reliably determined to be worth its cost can industrial policy truly be said to yield an improved economy.

Because industrial policy necessarily ignores market prices, however, there is no way for the designers of industrial policy, or for the mandarins who implement it, to know if the value of their engineered outcomes — here, more factory work and more factory output — exceeds or falls short of the value of the goods, services, and economic opportunities that are unavoidably sacrificed to achieve those outcomes.

When government engineers more resources into the building, equipping, and supplying of the particular kinds of factories favored by industrial-policy officials, we must ask: From where do these resources come? Some almost certainly come from other would-be manufacturing operations, while others come from the service sector. But no one can know any of these details. Yet even if we did know that, say, X tons of steel and Y hours of labor were diverted away by industrial policy from the service sector (say, from the building and staffing of medical-research facilities and online-retail distribution centers), how can we know that this altered allocation of resources will redound to the country’s net benefit? How can we know that the value of the output thereby lost from these service-sector operations isn’t greater than the value of the output thereby made possible in the manufacturing sector? How can we know that the particular jobs thereby destroyed in the service sector are inferior to the particular jobs thereby created in the manufacturing center?

We can’t know. No one can. There is literally nothing that tells anyone that the net result will be economic improvement for the country. Indeed, the only real knowledge we have when the reallocation of resources is first brought about is that, at least at that time, the market puts a higher value on the service-sector outputs that will no longer be produced than it puts on the additional manufacturing-sector outputs that will now be produced. We know this to be true because, were it not true, market participants themselves would have directed those resources away from the service sector and into the manufacturing sector.

In the face of this reality, industrial-policy champions have only two possible responses if they wish to defend industrial policy as being good for the country. One response is that the market is unreliable and its knowledge distorted. To those persons who offer this response it’s important to put this question: how do you know? What source of knowledge do you have that tells you with sufficient clarity that the knowledge conveyed by market signals is so defective that a government-engineered resource reallocation will improve the welfare of the people of the country?

If you ask this question you’ll get no good answer. Proponents of industrial policy ultimately are guided only by their personal tastes, preferences, prejudices, and hunches.

A second possible response from industrial-policy proponents is to concede that market prices and asset values accurately reflect today’s relative valuations of different outputs and resource scarcities, but then to assert that these prices and asset values reflect only current preferences and knowledge; because (the response proceeds) people today don’t fully appreciate how much better the economy would be with a different pattern of resource use and mix of economic outputs, today’s prices tell us nothing about what the ‘correct’ pattern of resource allocation should be tomorrow. Industrial-policy proponents insist that when government reallocates resources in accordance with industrial-policy plans, only then will market participants come to realize how much better the new resource-allocation pattern is compared to the pattern that would arise absent government intervention.

To this response, too, it’s important to ask the industrial-policy proponent: how do you know? What source of information do you have to assure you that you know better than do your countless fellow citizens, who today spend and invest their own money, what will be best tomorrow for these fellow citizens, nearly all of whom are to you strangers? Again, you’ll get no answer that satisfies. Whatever answer you do get will, upon examination, be seen to amount only to this: “I just have a feeling that I’m right that my industrial policy will improve the country!”