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A New Study of Industrial Policy

I thank Scott Lincicome for alerting me to this new study of Chinese industrial policy. Here’s the abstract:

A relatively mild form of government failure – for example, bureaucrats can count but do not differentiate quality – can significantly affect the efficacy of industrial policy. We investigate this idea in the context of China’s largest pro-innovation industrial policy using a structural model. We find that the return to the subsidy program is -19.7\% (but would be 7.8\% if the mild government failure can be removed). Furthermore, the welfare loss is exacerbated by patent trade.

And here are some highlights of this paper as noted, in an e-mail to me and a few others, by Scott:

  • “In particular, the 2008 policy shock has induced the initially less innovative firms – those with fewer than six patents – in the targeted industries to rush to achieve the desired level of patents for subsidy applications. In addition, a rising share of the new patents owned by them appears to be of low quality.”
  • “the share of patents sold to initially less innovative firms in the targeted industries exhibits the fastest growth after 2008. This is especially true for patents sold by either the firms outside the targeted industries, which are not eligible for a subsidy anyway, or by the firms in the targeted industries that already had more than six patents before the policy shock and hence do not need more to compete for a subsidy.”
  • “After calibrating the model to the data, we find that although the subsidy leads to an increase in the patent count by 33%, 98% of the increase is of low quality. This implies a notable decline in the average quality of the new patents”
  • “By comparing the welfare levels in the model with and without the subsidy program, we estimate the net social return to the subsidy to be -19.7%. That is, the society would be better off without this subsidy program.”
  • “the presence of even a mild government failure could convert an otherwise well-justified industrial policy from success to failure… While we focus on mild government failure here, we certainly do not rule out strong or semi-strong forms of government failure in practice. If corruption, lobbying, or incompetence is incorporated into our model, the return to the subsidy program would have been even lower (i.e., more negative). ”

DBx: On pages 36-37 of their paper, the authors observe – no doubt correctly – that to assume away even mild government failure “is not realistic.”

And so I say to those of you who worry that China is ‘unfairly competing’ against America economically by using industrial policy, you are correct! But the unfairness is not to Americans (as Beijing’s interventions make our economy stronger relative to China’s economy); it’s unfair to the Chinese people.