US industrial policy - a case against

Industrial policy: A panacea for US economic problems? Congress debates the creation of a government agency to pick industrial winners, shield losers, and channel investment.

Many economists and politicians see an industrial policy as a way to help ensure that America's economy remains productive and competitive in world trade, especially when compared with Japan. And the concept is expected to be embraced by some Democratic presidential candidates as their answer to President Reagan's economic policies.

But Charles L. Schultze - budget director to President Johnson, chief economic adviser to President Carter, and now an economist with the Brookings Institution - says an industrial policy is not needed, nor would it work:

* The United States is not ''deindustrializing,'' says Dr. Schultze. Relative to other countries, American industry is performing well.

* Japan's rapid rise is due all to a high savings rate, low-risk investment in already known technologies, and labor-management cooperation - not to government intervention.

* The US political system sidesteps the hard choices needed to pick winners and protect losers through government intervention.

Excerpts from the interview follow:

Q. What is meant by industrial policy?

Industrial policy is not so much one theory, as it is a loose collection of diagnoses of what's wrong with the economy, and some prescriptions.

The essential core is that, even if we were to attain overall economic prosperity, the government of the United States needs to take an active role in determining the composition of that prosperity, directing investment away from some industries and toward others.

That is, we need a governmental agency that will help protect some of the losers in our economy and restructure them and help pick some of the winners and get them going.

Q. What are the basic propositions around which the proposals for an industrial policy cluster?

There are two propositions. First, that the United States is deindustrializing. Second, that other countries, particularly Japan, have discovered a successful way of structuring industry to make for vigorous industrial progress.

Q. Has the US in fact been deindustrializing?

The deindustrialization of America is really a myth. Relative to other countries, by almost all standards, American manufacturing did relatively well in the 1970s. Total employment in the US grew vastly more than in any other country in the world. Our total employment grew by about 24 percent in the decade of the 1970s. The next best was Japan, with 12 percent. West Germany had a decrease.

In the case of manufacturing employment, which is more to the point - the United States was about the only country, aside from Canada and Italy, which had any increase in manufacturing employment. Again, Germany had a fairly noticeable decrease.

The share of total GNP (gross national product) contributed by manufacturing in the US always goes up and down as the economy booms and busts. But if you extract that cyclical fluctuation, you find that over the last 20 to 25 years the share of total GNP accounted for by manufacturing in the US has not declined.

Manufacturing exports in the US doubled in the decade of the 1970s - less than Japan, but again more than the European average. There is no evidence of deindustrialization, absolutely or comparatively.

Q. Within the manufacturing sector, do we have to distinguish between the old-line heavy industries and high-tech industries?

If we have decent economic policies in periods of normal prosperity, people are able to make the switches which economic progress always imposes. Some industries reach maturity, level off, and decline. Other industries grow. The question is whether we are capable both of generating the growth industries and of having our labor and capital make the transition from old to new.

Q. Are we?

All the evidence is that, during normal prosperity, we are able to do that with a few exceptions.

Q. Did the 1981-82 recession change this picture in any way?

Clearly, during the recession, manufacturing was hit much harder than the rest of the economy. But that always happens. Manufacturing is now, as you might also expect, rising faster in the recovery than other sectors. For example, in the first half of 1983, GNP rose at a rate of about 5.5 percent. Manufacturing production rose at a little over 16 percent annual rate.

Q. During the 1970s the growth rate of US productivity, or output per person, declined. Does this reflect structural problems?

Decline of productivity is a very serious problem - in the long run, perhaps the most serious economic problem the country faces. A lot of the reasons for this decline we don't know. But we can make a very good estimate that it was not due to deindustrialization. The decline in productivity growth during the 1970s occurred all over the world. The US is about midway down the list in terms of the size of the decline. There is no evidence that manufacturing productivity declined more than that of other industries. In fact, there is some evidence that it declined less.

Q. To turn to the second basic proposition: To what extent is an industrial policy in Japan responsible for that country's economic success?

Industrial policy, as administered by MITI (Ministry of International Trade and Industry) has been much overrated as the explanation for Japan's success.

Japan does have characteristics that make for successful industries. The Japanese work together cooperatively without a lot of red tape and without dulling the competitive edge. However, if you look at the factors for Japanese economic progress in the postwar period, three things stand out, no one of which is associated with industrial policy:

1. The Japanese save and invest some 30 to 35 percent of their gross national product, compared with 17 to 20 percent in the United States.

2. The Japanese were able, with a technological plant far inferior to that of the United States, to invest those huge savings at low risk and high return in already known successful ventures, improving on them as they went.

3. The Japanese developed a system of labor-management relationships with many advantages, including the ability to elicit high-quality, productive work.

MITI did play a role, but a relatively modest role. Most of the big decisions were made by Japanese business, with MITI encouraging rather than originating.

While MITI had some successes - for example, with the Japanese development of the 256K memory chip - it also had a lot of failures. MITI tried to keep Honda out of the automobile business. MITI tried to get the Japanese heavily into commercial airlines and the banks just wouldn't follow.

People seem to have the idea that, if MITI hadn't been around, that huge investment in Japan somehow would have gone into plastic toys, souvenirs, and fisheries. Well, it wouldn't have. Given the aggressive quality of the Japanese businessman, it probably would have gone where it went anyway. The contribution that MITI made by pushing, shoving, and nudging was good in some cases, probably bad in others, but on balance was not the major factor in Japanese success.

Q. In the postwar years the Japanese were able to capitalize on technology already developed elsewhere, notably the US and Germany. Now that Japan's own technology has caught up, is government intervention better able to help the Japanese than would be the case here?

No, I'd say almost the opposite. In a world in which you have an example to follow - as Japan did in 1960, looking at the US to see what a modern, technologically advanced, industrial country was like - it is easy for a government agency to say: Here are some areas which we ought to follow up. When you're up on the technological frontier yourself, however, then the whole question of industrial advance becomes one of a decentralized search in areas where no one is exactly sure where you are going to end up. Here the private market system, with decentralized searching and the profit motive, is going to have a much greater chance in this trial and error way of making a breakthrough than a government agency is.

As the Japanese have caught up - and they have - it is becoming much harder for them to grow so fast. Roughly, from about 1960 to 1973, the Japanese economy grew at 10 percent a year. They invested their huge savings in fairly obvious ways. Now, they have caught up. They still have their huge savings rate, but their investment opportunities have shrunk substantially. As a consequence, the Japanese for the last five years have been growing at something like 3 to 4 percent a year. The prospects are for something like that in the future. They find themselves in a world in which it is much harder to grow, when you are at the technological frontier with the leaders.

Q. For an industrial policy to be successful, it must be able to pick winners and protect losers. Is the US government, or any agency that might be set up, better able to pick winners than the markets themselves?

Far from it. We really don't have any objective economic criteria which determine, in detail, what particular lines of activity or products a nation is going to be successful at.

Standard economic theory tells you that comparative advantage, or what a nation is good at, depends on the relative scarcity or abundance of things like labor, capital, and raw materials. To a certain extent that is important. Industrial countries tend to have an advantage in technologically oriented, research-based products that require a skilled labor force to produce. Certain natural resources are relevant.

But apart from that, what determines what a country will be good at has little to do with things you can identify in advance. A lot of it, believe it or not, comes from a combination of sheer coincidence and inertia. That is, if you have a good environment for progress, there are a lot of entrepreneurs out looking for a niche in the market.

In this process, once you begin to get success, success breeds on success, because once a nation gets a foothold in some particular niche, all sorts of advantages begin to accrue. Workers get more skilled, management picks up knowhow, ancillary firms develop just to supply that industry.

For example, as Swedish economist Assar Lindbeck points out, there is nothing in the Swedish national character, or Swedish natural resources, which would have led you to believe in advance that the Swedes would be preeminent in the field of automatic lighthouses, cream separators, safety matches, or the Japanese in motorcycles, or the US in pharmaceuticals.

Q. What is the proper government role, based on compassion for people who are badly hurt by import competition, in protecting the losers?

There are two basic ways society can go about trying to reduce the pain that comes from economic change. Economic dynamism necessarily means change. Change is painful.

Society can try to slow down, or prevent, or put roadblocks in the way of change. That will reduce some of the pain, at least in the short run.

The other way is to let economic change take its course, but then to provide retraining, unemployment compensation, relocation allowances, and the like, to make people better able to adjust to the change.

Clearly, neither way is perfect. A consistent, systematic effort to prevent change will reduce pain in the short run, but in the long run will substantially reduce the dynamism and economic progress of a nation and have major harmful effects on its productivity growth.

Q. Since there would be a limited pool of capital to implement any industrial policy, are you saying that capital would tend to be directed in the wrong ways, hurting the economy overall?Exactly. The whole idea of industrial policy is not to increase total investment, but to reallocate it. That means, if you are going to put more money into some industries, you have to take it out of others.

Q. Does our political system militate against government making the critical choices among industries, firms, and groups of workers?

One cardinal principle of American policy is never be seen to do direct harm. Our entire system is set up to avoid the government making invidious choices among individuals, or regions, or municipalities - precisely the kind of hard choices that would have to be made if an industrial policy were to be more than simply a political pork barrel.

To give one example: We have an Economic Development Administration, set up to help depressed areas. By the time the EDA got through Congress, a little more than 80 percent of the counties in the United States qualified as depressed areas. Whatever agency was set up would have to say, ''The cotton textile industry is capable of restructuring, but the wool textile industry will have to die. Steelworkers, who have a very large wage premium relative to other manufacturing workers, will have to give that up.''

I can't conceive of this happening. The market should make that kind of decision and government should be there to help ease the adjustment. Nobody should pretend that the American government is capable of doing more.

An expanded version of this interview, conducted by Mr. Ellis, is being aired over public radio as part of a series called Focus. Subject of the broadcast is an article by Dr. Schultze - ''Industrial Policy: a dissent'' - in the current issue of The Brookings Review.