Trade, Technology and The Allure and Illusion of Industrial Policy

Contributor - Pravash
January 29, 2025
6 min read

The siren song of industrial policy is back, promising to revitalise domestic industries, counter foreign threats, and restore economic greatness. But before we rush to embrace this seemingly common-sense approach, it’s worth examining the arguments more closely, through the lens of economic theory and historical experience.

What is Industrial Policy?

It can be defined as a government policy that aims to reshape the economy in a way that differs from a free market outcome to achieve a national goal. Examples include policies aimed at influencing international trade flows, bolstering national security, addressing environmental issues, or resolving regional economic problems.

Vulgar Mercantilism and the Public’s Misunderstanding of Trade

One of the most common arguments for industrial policy is rooted in what economists call “vulgar mercantilism.” This line of thinking, often fuelled by a flawed understanding of trade, fixates on trade deficits and job losses in industries facing foreign competition. It views imports as a drain on the economy, neglecting the crucial role of exports and the benefits consumers derive from lower prices and a wider variety of goods. This perspective ignores the fundamental principles of comparative advantage and the overall gains from trade that accrue to society as a whole.

The appeal of this simplistic view lies in its intuitive nature. It resonates with our innate anxieties about job security and national competitiveness, especially when those anxieties are amplified by fears of a rising China or other perceived economic rivals. This fear often spills over into xenophobia, as we become more suspicious of trade partners who look, sound, or govern differently from ourselves.

The Economist’s Case for Free Trade

Economists, however, offer a compelling counter-argument, grounded in the principles of free markets and comparative advantage. Free trade, they argue, leads to greater overall wealth by allowing countries to specialise in what they do best and exchange goods and services with one another. This increases efficiency, lowers prices, and expands consumer choice, ultimately benefiting society as a whole. While acknowledging that trade can cause localized job losses and economic hardship in certain sectors, economists maintain that these are transitional costs outweighed by the long-term gains from a more globally integrated economy.

The challenge lies in measuring the true impact of free trade and disentangling it from other economic forces, such as technological advancements and domestic policy choices. Critics often point to specific industries or regions that have suffered job losses due to trade, but they often overlook the broader picture of economic growth and job creation in other sectors. Additionally, the benefits of free trade – lower prices, increased variety, and greater innovation – are often diffuse and difficult to quantify, making them less salient in public discourse.

National Security and the Argument for Government Intervention

The debate over industrial policy is further complicated by the issue of national security. Proponents argue that certain industries are too vital to national security to be left to the whims of the market, citing examples such as semiconductor manufacturing and critical raw materials. They advocate for government intervention in the form of subsidies, protectionist measures, and even outright bans on foreign investment in these strategic sectors.

While national security concerns are undeniably important, economists urge caution, warning against overstating the threat and resorting to protectionist policies that could ultimately weaken the economy. They point out that history is replete with examples of exaggerated threats and misplaced fears. They argue that the ability of businesses to adapt and find alternative sources is often underestimated, and that excessive government intervention can stifle innovation and create inefficiencies.

Neoliberalism and the Shift Toward Nationalism

The period from the 1980s to the 2010s witnessed a rise in neoliberal policies, characterized by a greater emphasis on free markets and globalization. This period saw a significant reduction in global poverty and was fueled by the perceived discrediting of interventionist economic policies. However, in recent years, there has been a global shift away from neoliberalism and towards nationalism, leading to concerns about a return to less-free markets and increased industrial policy.

The shift from neoliberalism to nationalism in recent years has further emboldened proponents of industrial policy. This resurgence of economic nationalism, fuelled by anxieties about globalization, job displacement, and the rise of China, has led to a growing appetite for government intervention in the economy. However, this shift towards a more interventionist approach comes with its own set of risks.

The United States’ Fiscal Policy and the Potential Consequences of an Unsustainable Deficit

One of the most concerning aspects of this trend is the disregard for fiscal responsibility. As governments ramp up spending on industrial subsidies and other interventionist measures, budget deficits and national debt levels continue to soar. This reckless fiscal policy, economists warn, could lead to higher taxes, higher inflation, or both, ultimately undermining the country’s long-term economic prospects.

The current economic landscape presents a stark contrast to the period of neoliberal globalization, which witnessed a significant decline in global poverty and a surge in economic growth in many developing countries. While this era was not without its flaws, it demonstrated the power of free markets and open trade to create prosperity and lift millions out of poverty. The resurgence of protectionism and economic nationalism threatens to reverse these gains and usher in an era of greater economic instability and geopolitical conflict.

Concluding Thoughts

The economist’s case for free trade and limited government intervention is not about ignoring the legitimate concerns of those who are negatively impacted by globalization and technological change. It’s about recognizing that protectionist policies are ultimately a false promise, offering short-term relief at the expense of long-term prosperity. Addressing the challenges of economic dislocation requires a different approach – one that focuses on investing in education and retraining, promoting labour mobility, and creating a safety net that protects those who are most vulnerable to economic disruption.

In the end, the allure of industrial policy lies in its simplicity and its appeal to our baser instincts of fear and paranoia. It offers seemingly easy solutions to complex problems, promising to restore a bygone era of economic dominance and national security. However, this approach ignores the hard-won lessons of economic history and the proven benefits of free markets and open trade. If we are to navigate the challenges of a rapidly changing global economy, we must resist the temptation to retreat behind protectionist walls and instead embrace a more nuanced and forward-looking approach that prioritizes economic freedom, innovation, and global cooperation.

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