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Further Thoughts on Industrial Policy

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 Marianna 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. To better see what I mean, let’s assume away the challenges mentioned above. Let’s assume, unrealistically, that when the government subsidizes Jones to build a better mousetrap, this intervention is destined to succeed – meaning, this intervention will raise living standards beyond what these standards would otherwise have been.

What resources, exactly, does the government’s transfer of funds from Smith to Jones put into Jones’s hands? The actual dollars that the government gives to Jones are, as physical pieces of paper or as digital entries in a bank account, useless as such for improving mousetraps. Monochrome portraits of dead American statesmen – or digital representations of these portraits – cannot perform R&D, power an assembly line, or serve as useful components in a mousetrap. Instead, Jones spends these dollars buying the real resources that he needs to carry out his project. He hires more labor and buys electricity, steel and concrete, plastics, computer software, transportation services – the list is very long.

The workers who Jones employs are nourished by food purchased at privately owned and operated supermarkets and restaurants. Most of these workers travel to and from their job sites in automobiles manufactured and fueled by private enterprise. The electricity that courses through Jones research lab and factory is generated and transmitted using machines and wires produced by private industry. The steel, aluminum, glass, and reinforced concrete from which his factory is built are overwhelmingly the products of private market processes, as is the smartphone and each of the apps that he relies upon to communicate with his workers and bankers – the latter of whom years earlier supplied the private funds that Jones used to launch his foray into the mousetrap industry. Even if Jones and everyone else would, without government subsidies, have refused to embark upon an effort to build a better mousetrap – and even if it’s also true that this particular better mousetrap turns out in the mind of the Almighty to be a worthwhile project for society – this mousetrap improvement nevertheless undeniable relied heavily upon a previously established and well-working market-created pattern of resource allocation.

In this example in which an industrial-policy intervention succeeds (albeit by assumption), the competent economist doesn’t hesitate to credit the improved mousetrap to state intervention. The competent economist doesn’t insist that, because this intervention’s success depended upon a pre-existing pattern of resource allocation overwhelmingly determined by the market, this particular mousetrap improvement should be said to be largely the result of market processes. Nope. For this mousetrap improvement, full credit goes to the government.

But the very same logic that leads the competent economist to this conclusion leads her also to avoid an error routinely committed by industrial-policy enthusiasts – namely, mistakenly crediting the government with the successes of markets. The competent economist, for example, correctly concludes that the successes of Walmart and Amazon are not caused by the government officials who years ago arranged to build and maintain the nationwide network of roads on which these retailers’ delivery vehicles travel. Instead, these entrepreneurial successes spring from the creativity and ingenuity of their founders and executives. The improvement in their fellow human beings’ living standards that these retailers make possible is created exclusively by them. It’s not created by the state.

Of course, in building this road network government officials undoubtedly anticipated that the roads would be used for productive purposes, just as they surely also understood that some motorists would be killed on these roads. But these officials had in mind nothing and no one in particular; they certainly didn’t foresee Walmart and Amazon. These officials simply arranged to build roads. Therefore, to credit the government with the successes of Walmart and Amazon just because these companies use government roads is as illogical as would be holding the government blameworthy for every traffic fatality caused on its roads by drunk drivers.

More generally, it’s utterly inappropriate to chalk up to the state the successes of private entrepreneurs just because the state today performs such activities as funding basic scientific research, subsidizes formal schooling, dredges harbors and plows snow-covered streets, and allows business expenses to be deducted from taxable income. Reasonable people can and do argue over just how much the government should be involved in these (and countless other) activities. Only unreasonable people, however, credit all entrepreneurial successes in the market to such activities and then further conclude that more detailed government involvement in allocating resources is necessary to improve overall economic performance.

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