[Glenn Athey] It seems that in the UK our policies have actively promoted certain industries, without this being the explicit goal – for example with the promotion of financial services and consumer and leisure sectors on the back of easy credit and lax regulation and oversight. Its easy to say “leave it to the market” – but can we live with the consequences (as we are doing now). This article takes a balanced look at industrial policy and how it works in some other parts of the world. If we all think that industries such as semiconductors, the internet, mobile telecommunications, medical scanners and vehicles emissions systems are useful and have generated significant wealth and societal benefits, then, as they all benefited substantially from some form of government policy and assistance – we need to acknowledge that governments have a role in the economy and in formulating industrial policy.

Post crisis: the need to create wealth and jobs

In the post recession environment, we need to generate economic growth and new jobs to replace the ones we’ve lost. Governments and concerned citizens are quite rightly concerned about how they will achieve this. This then leads them to think about in which kinds of activities that growth prospects lie, and if they can stimulate growth that goes further and faster than might have ordinarily been the case. High growth firms and global corporations generate wealth, employ lots of people, and generate tax income. If it is not in the national interest to enable and cultivate these benefits, then what is?

And this is where the notion of ‘industrial policy’ comes in – where governments play a role in facilitating or enabling growth in certain growth firms or industries. Think of all the ‘usual suspects’ for case studies in growth, such as Dubai, Finland, Singapore, Silicon Valley and Taiwan. In all cases, governments have played significant roles. Industrial policy is alive and well, and there are successes, despite those who deny government has a role in economic development. As a report from the UK’s National Endowment for Science, Technology and the Arts (NESTA) recently put it “intervention driving growth is the norm, rather than the exception, in modern economic history.” (Medway and Mateos-Garcia, 2009). Josh Lerner, in his recent book (Lerner, 2010) concluded that appropriate industrial policy is a necessary prerequisite to the development of successful new industries.

The popular misconception about industrial policy

Unfortunately the ‘industrial policy’ brand has been long corrupted as being synonymous with governments ‘picking winners’ and disastrously getting this wrong, often wasting billions in the process. However, for every disaster such as British Leyland, there are also the massive success stories of Silicon Valley and Airbus which have both benefited from a very significant government role. And then there are places such as Singapore and Dubai who have pretty much created successful new economies from nothing over the past fifty years. If we all think that industries such as semiconductors, the internet, mobile telecommunications, medical scanners and vehicles emissions systems are useful and have generated significant wealth and societal benefits, then we need to acknowledge that governments have a role in the economy and in formulating industrial policy.

We need industrial policy to enable recovery from the credit crunch and the recession. Industrial policy has already leapt to the rescue of many banks, with governments taking 80 per cent or even complete ownership. If we think that the financial sector is too big to fail, then surely the means of production and wealth generation are surely too big and important to fail too.

Everyone’s doing industrial policy (even those who deny it)

Often, when you scratch beneath the ‘small government’ rhetoric you can find hefty government interventions in industries. Despite Ronald Reagan’s famously pithy statement that “the nine most terrifying words in the English language are, ‘I’m from the government and I’m here to help’” – his administration did provide a substantial boost to domestic US defense and aerospace industries via a 40 per cent increase in defence spending between 1981 and 1989. Historically, the USA has such an incredibly large track record and legacy on industrial policy, largely founded on the back of significant military and aerospace research contracts.

And then there are the emerging economies, and the large successful companies that are increasing their global presence. Out of the 23 Chinese companies in the 2010 FT 500 list of the biggest companies in the world by market capitalisation, all began as government – owned enterprises, all remain either state owned, state controlled or owned by local government. The largest company in the world by market capitalisation, PetroChina, is Chinese and state-owned.

Can we all agree that semiconductors, the internet, and mobile telecommunications have been beneficial?

Semiconductors, the internet, mobile telecommunications – all technologies and major industries that were spawned from government intervention and industrial policy. And they have changed the economy, and the world for ever. Semiconductors have revolutionised the world economy and have led to such massive technological and industrial change – all increasing the wealth and quality of life of citizens like you and me. Many private companies have benefited from initial government funding and support for these technologies and industries, whether in the form of research grants, favourable tax regimes, or changes to legislation.

Shoot the pork barrel, not the messenger

The trouble with industrial policy is that it is more often than not falls prey to vested interests. Once certain businesses (and their lobbyists) know that there are tax dollars available for business, or that their existing subsidies or special policies are at risk, then they will swing into action to try to capture public funds, or preserve the funding or favours that they have got. They often capture the resources that were meant for something else, or they can be used to prop up industries and ways of doing things that are not in the interests of long term economic growth and development.

Often this is what gives industrial policy a bad name. However, it is the same for every other form of policy. In finance, for example, banks don’t want to be regulated, but they don’t mind it if the state guarantees their losses (as happened in the recent credit crunch). Both education and health sectors are subject to the significant interest and influence of their professional bodies. Energy policy is subject to various industry lobbies, be they nuclear, petrochemical or ecological. So vested interests are a facet of every area of government policy, and are not unique to industrial policy.

Bureaucracy can be helpful, but could probably be improved

Vested interests not necessarily acting in the public interest are often why governments have rules about public assistance to firms and industries. How helpful these rules are to industrial development is an open question, however. For example, the European Union has its State Aid rules which all member countries are expected to follow and are aimed at avoiding conferring commercial advantage to one large company through public expenditure or policy. However existing State Aid rules would not tend to enable what governments in places like the USA, China and Singapore have done to develop new industries. Most western governments have competition policies and watchdogs. Many firms and industrial interests will claim that this bureaucracy is preventing them getting hold of public funding. Whilst it might be bad in terms of closing off a number of policy options, there are also benefits in terms of preventing things like corruption and the protection of vested interests which act to prevent economic development and not promote it. We probably need competition and state aid types of rules but might want to look again at whether they might be improved to better encourage the creation of wealth and new jobs.

Silicon Valley, POSCO, Dubai’s Jebel Ali port, Brazil’s aircraft industry, Taiwan and Singapore’s electronics industries all had significant government interventions…

Silicon Valley is possibly one of the greatest government interventions of all time. As the Council for Industry and Higher Education concluded in their recent policy statement for growth in creative, digital and information technology industries in the UK (CIHE, 2010), the true story of Silicon Valley is one of private equity leveraging intellectual property created by government investment.

Silicon Valley has experienced five phases of development and in each on, public funding was central to success. In phase I, Hewlett Packard and Varian, the Valley’s foundation businesses, benefited from significant increases in demand for electronic products from the UK military during the Korean War. In phase II, the Shockley, Fairchild and Intel semiconductors businesses all made their early business and reputations through military support. Personal computing emerged from the US government funded Advance Research Project Agency (ARPA) which sponsored the first computing programmes at Stanford University. ARPA then funded Unix and the Internet.

Eleven lessons from the past

Josh Lerner, in his recent book (Lerner, 2010) neatly summarises the lessons and pitfalls from industrial policy. Using these lessons, and adding a few of my own observations – I’ve put together 11 lessons for industrial policy below.

1. Industries need a holistic range of favourable conditions to thrive

Governments need to take a broad view. Entrepreneurialism and market activities do not exist in a vacuum. Entrepreneurs need business services, skilled staff, investment finance and customers nearby. Just constructing buildings or science parks does not automatically create an industry. This is why, several years ago, policies started emphasising ‘clusters’ – tacit acknowledgement that a range of supply and demand side factors needed to be in place, and that a healthy and dense set of market interactions and transactions were needed.

2. Building the ‘Field of Dreams’ will only really work once you have a team in place to occupy it

In 2000 the author of this article was undertaking research on the software and games companies in Dundee. I remember these firms being deeply unimpressed with the local science and technology parks. For half the rental cost, and given long lead times to market, they found cheap office space in plentiful supply with all the internet connections they needed. In 2001 the Malaysian government decided to invest $150 million in their ‘Biovalley’ 2,000 acre biotechnology campus, but without much of a domestic biotechnology industry nor any real interest by international investors. By 2005, the site remained empty and the government changed policy and neglected Biovalley.

Buildings are obviously useful, but they are not the anchor nor the initial stimulus to new industrial growth. There needs to be some existing demand and critical mass at the location for such property-led projects to succeed. The new open innovation centre in Glaxo Smithkline in Stevenage, UK sounds interesting in this regard – it is an innovation incubator set within an existing corporate R&D headquarters, with the aim of creating a more fluid range of spin-outs and suppliers of drug discovery R&D.

3. Success often needs to be anchored in locational advantage

Most successful industries or clusters have grown on the back of some kind of major local natural or human assets. In the past 50 years, success in leveraging the academic and scientific research base has led to the development of new global industries and emergence of regions such as Silicon Valley. Taiwan created a semiconductors industry on the back of a successful heavy engineering and engineering design sector.

4. Successful industries work globally

Success needs global approaches. Government regulations, taxes and services need to conform to, or be superior to global standards. Global investors, customers and suppliers are likely to be discouraged if their customary approaches to business cannot be applied in a given nation. For example, New Zealand’s attempts to develop a venture capital industry did not make any progress until they implemented the regulations and conditions of tax liability and ownership that were common in all other nations which had successful global venture capital funding.

5. Industries are not technologies

Successful industries tend to have large ‘footprints’ of activities and supply chains. Technological development and change has helped to form new industries, but then so have consumer behaviours and patterns of demand. To some extent this point is similar to the one NESTA made in its ‘Hidden Innovation’ publication (NESTA, 2007) – that innovation does not equal technology. Policy initiatives such as the UK government’s New Industries New Jobs policies in 2009 to 2010 tended to focus on technology, but arguably didn’t have sufficient focus on the prospects for commercial advantage and capacity. Advanced technology does not always make it to market. There are plenty of examples of technologically superior products which turned out to be inferior in terms of their attractiveness to the market and their commercial returns.

6. Follow and use the market to pursue your policy objectives

Successful industrial policy follows the direction of the market by design. This often involves the development of effective incentives and flexible interventions. Governments should use market knowledge and analysis to guide their investments. Markets respond to market conditions and incentives. Governments should also avoid rigidly designed policies and interventions. Often governments overly prescribe solutions, whereas they are often not well informed enough to design interventions on the ground.

7. Avoid being pressured by vested interests into developing inappropriate policies and activities

All government policy, as well as industrial policy is subject ‘agency problems’ (i.e. vested interests taking over and trying to capture funding). They are universal and governments must take steps to minimise their danger. This is where rules and regulations come in, and the rigorous testing of projects and funding bids for market distortion and prospective economic impacts. It is also where the close scrutiny of existing industries is warranted. In the past, a lot of industrial policy has gone towards keeping outdated industries and industrial practices alive. Whilst this may be necessary in terms of smoothing the structural adjustments in the economy, it cannot last forever. Policies must either try to manage decline or manage transformation and evolution.

8. Evaluation not affirmation

By affirmation I mean the use of descriptive and complimentary case studies which tell a positive story but rarely probe deeply into the performance of industries, firms or initiatives. If we’re serious about really boosting our local economies, then we need to get beyond the gloss and boosterism of affirmative statements. At times like these where public expenditure is under scrutiny, wouldn’t it be helpful to be able to objectively and precisely prove the worth of particular policies and approaches that made a difference to your local and national economy? This is difficult to do unless you have instituted a rigorous and transparent programme of evaluation and can demonstrate you have consistently tried to improve policy and practice over time. To some, this sounds like needless bureaucracy. But to others (the treasury officials), they simply won’t believe your claims and promises unless you have the hard evidence to back it up.

9. The best industrial policies enable industrial development – allowing winners to pick themselves

In their examination of a new approach to supporting growth businesses in the West Midlands (the Mustard Programme), Patton at al (2003) concluded that the best support programmes allowed winners to pick themselves. The role of the public sector was to offer a gateway to support and assistance to firms with growth ambitions, signposting them to both private and public sources of help and support.

The real lesson here is in the enabling role of industrial policy and practice – achieving the right conditions and environment for growth, and building supporting activities to help potential winners to thrive in a competitive environment.

10. Industrial policy by any other name

We often hear about innovation policies, and new initiatives to promote the ‘new economy’, ‘green economy’, or ‘knowledge economy’. Essentially these are all industrial policies. Industrial policy as a concept is broad, and involves the enabling and support of growth and development of existing and new industries.

11. Industrial growth takes a long time and needs consistent, long term support

Lastly and perhaps most significantly, recognise the long lead times for industrial policy. You cannot create new industries and substantive new firms overnight. Regular, substantive changes to policy and support services and institutions will not inspire confidence in your nascent growth industries – they will simply not believe that government is truly committed. The best examples of industrial policy – such as Silicon Valley, Taiwan and Singapore – took many decades for new industries to develop and grow and resemble the mature and world competitive centres they are today.

Creating locational advantage requires local economic development activities

We all know about Richard Florida’s famous line that “innovation is spiky” which reinforces the point that most industries and their supply chains enjoy various kinds of benefits from proximity. Industries and economic specialisms cluster geographically.

And this is where local economic development comes in. Issues of skills provision, infrastructure, and land supply all operate locally. And a major company’s supply chain is likely to be clustered locally or regionally. Local organisations and authorities can and should play a role in industrial policy. They play a critical role in shaping the competitive business environment in their areas, as well as troubleshooting specific problems or challenges.

Long live industrial policy

In a recent debate on the statement by the Economist in June 2010 that “industrial policy always fails”, the reader’s poll indicated that 72 per cent of respondents disagreed with this statement. The general feedback by voters about the debate was that government policies and activities to enable and sustain growth industries were quite diverse, and that governments picking winners and trying to dictate business strategies was now a rare occurrence.

Industrial policy is alive and well, especially in emerging economies, although as noted above it is not often called ‘industrial policy’ these days. Instead we refer to it as innovation policy, the knowledge economy, growth business policy, or as specific industrial initiatives such as ‘stimulating creative industries’.

Doomed to Choose – how we’re making industrial policy choices without often knowing about it

As Dani Rodrik (2006) says – we’re doomed to choose in industrial policy. If we step back and do nothing, and perhaps emphasise free trade, property rights and do not regulate financial markets and property – then its likely that monopoly, rent seeking financiers and property owners will emerge as the dominant economic activity and will disincentivise industrial and scientific development (sound familiar to anyone?).

However – he also says “governments don’t have the requisite information to pick winners but even if they did, they may not have the incentives to do so and if they tried, they would set off powerful rent-seeking behavior that will distort the achievement of the good intentions that motivated them in the first place. The proverbial road to hell is paved with well meaning industrial development plans (p2.) … “Industrial policy is hard, but that is no argument against its use. Fiscal policy, say, or education policy is hard too, but few people would argue that governments should just give up on them. Theory and evidence have convinced us that governments need well designed tax and expenditure programs and that they must invest in human resources. And so it is with industrial policy. Governments need well articulated strategies to provide the specific inputs that markets need in order to foster the structural transformation that drives economic development. ”

One of my personal reflections of the past 20-30 years of the UK is that it has operated a few industrial policies by proxy – support for the defence sector; support for financial services via deregulation and the recent bailouts. And the glut of cheap credit ended up being spent on consumer goods and property which caused a consumer credit and housing boom that turned out to not be sustainable. This has hardly been very strategic, nor has there been a careful consideration of the levers that governments operate.  The result – a serious recession, and a long climb back to prosperity.

Long live industrial policy – ignore or deny it at your peril.

References

Council for Industry and Higher Education (2010) The Fuse – Igniting High Growth for Creative, Digital and Information Technology Industries in the UK, London: CIHE.

Lerner J (2010) Boulevard of Broken Dreams – why public efforts to boost entrepreneurship and venture capital have failed and what to do about it, Princeton: Princeton University Press.

Meadway J and Mateos-Garcia J (2009) Demanding Growth: Why the UK needs a recovery plan based on growth and innovation, London: NESTA.

Patton D, Marlow S, Ram M, and Sanghera K (2003) Interpretive analysis as an evaluative tool: the case of Mustard.UK.Com, a high-growth small business programme, Environment and Planning C: Government and Policy, Vol 21(6), pp. 813-824.