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Further Thoughts on Industrial Policy

In my latest column for AIER I offer further, critical thoughts on the case for industrial policy. A slice:

Supporters of industrial policy often argue in the following way: Sometime in the past government raised Smith’s taxes, gave the proceeds to Jones, and Jones then used these proceeds to build a better mousetrap; it follows that government is responsible for better mousetraps in particular, and, more generally, for whatever contribution better mousetraps make to economic growth and human flourishing. Therefore (continue industrial-policy supporters) history proves not only that industrial policy bears real and wonderful fruits, but also that an ample supply of such succulent fruits can be assured only through industrial policy; productive resource allocation is best achieved by government direction and not by free markets. (For a specific example of this line of argumentation see Mariana Mazzucato’s claim that the US government invented the internet.)

But such reasoning is filled with fallacies.

Perhaps the most obvious of these fallacies is the failure to ask the economist’s core question: “As compared to what?” Had the government not directed resources away from Smith to Jones for the latter’s better-mousetrap project, these resources would have been used in some other ways. What these other ways are we’ll never know. But the possibility must be admitted that, had he been allowed to keep the money that the government took from him, Smith – either directly or through a financial intermediary – would have used these funds in ways to generate results even more valuable to society than is Jones’s better mousetrap.

Of course, it’s also possible that, absent this tax, Smith would have frittered these funds away on prostitutes and drugs, or invested them in a chocolate-covered-pickle venture destined to fail. We just don’t know – but neither do industrial-policy proponents. Yet because these funds might well have been used even more productively by Smith than by Jones, it’s undeniable that a positive market value of the better mousetrap created by Jones with Smith’s funds is insufficient to prove that industrial policy successfully raised society’s economic well-being higher than it would have risen without the industrial policy.

A second fallacy in the reasoning of industrial-policy advocates is the unwarranted assumption that because government intervention led to the creation and production of Jones’s better mousetrap, had the government not intervened humankind would forever, or at least for too long, remain without a better mousetrap.

As before, perhaps this assumption is correct, but perhaps it isn’t. No one can know. If the value that consumers attach to mousetrap improvement is sufficiently high, it’s reasonable to expect that entrepreneurs would work without subsidization to make such improvements a reality. But how do government officials know that a better mousetrap is worth the cost? They don’t. And even if we grant that a better mousetrap would be worthwhile, how can government officials know that the recipients to whom they dispense the subsidies are those entrepreneurs or firms best able to achieve the improvement? The possibility is real that the subsidized mousetrap improvers displace unsubsidized mousetrap improvers who, absent the subsidies, would have given the world an even better mousetrap or an equally improved mousetrap produced at lower cost. The fact that government intervention leads directly to a better mousetrap is insufficient to prove that this intervention worked even on its own terms.

A third and more subtle fallacy is worth noting – namely, the mistake of crediting government with successful market outcomes simply because the entrepreneurs and businesses who spark these outcomes do so in a real-world environment featuring plenty of government interventions.