Industrial Policy: A Blind, Lame, and Drunk Donkey

(Don Boudreaux)

Here’s a letter to a Café Hayek reader:

Mr. T___:

Impressed with Oren Cass’s performance against Scott Lincicome in the Soho Forum debate over industrial policy, you wonder why I, in this earlier letter, “ignore Cass’s point that market don’t account for the country’s future needs.” (I listened again to the debate. You accurately report Cass’s position, which he stated like this: “If we want to have a strong industrial base we need to make sure our economy is one that is, in peace time as well as war time, maintaining a strong domestic capacity in a whole host of areas. Obviously, that’s not something that markets are going to take into account. That’s not something price signals are going to ensure. And so if want it to happen, there’s going to have to be a role for policy.”)

Cass is wrong. Understanding neither the role of financial markets nor of prices, he swallows the pedestrian fallacy that markets serve only the short run while government serves the long run. The truth is the opposite.

Today’s asset prices reflect expectations of these assets’ future uses: the more productive these assets are expected to be, and the longer the time horizons over which this productivity is expected to last, the higher are the market values of these assets today. This reality explains, for example, why homeowners who know that they’ll soon move out of their current homes nevertheless often pay big money to repair and refurbish their homes. They pay these sums not out of any sense of generosity to the future buyers but because such expenditures raise the value of the homes today by making them nicer homes over the course of many years to come. These future values are captured by current homeowners in the higher prices for which they’re able to sell their homes.

Likewise, investors and entrepreneurs, seeking returns as high as possible, invest in those projects and businesses that they believe have the highest net present values – that is, the highest expected net productivity over time. They don’t always get it right, but because they spend their own resources, they have powerful incentives to do the best they can, which includes taking a sufficiently long-run view.

The situation with government officials is quite different. Those charged with executing industrial policy neither spend their own resources nor have ownership stakes in the results of their decisions. Their personal wealth doesn’t rise if they make good decisions; it doesn’t fall if they make poor ones. Therefore, government officials are much more likely than are private investors to be guided in their decisions by today’s short-run political fads and fancies, or even by their own idiosyncratic whims and notions, however detached these might be from reality.

Many more errors are packed into the above-quoted remarks by Cass. Not least of these is his unsupported presumption that government officials can know what are the ‘best’ industries to support with tariffs, subsidies, and other special privileges, and can know what are the most cost-effective ways of providing such support. Remember that all resources used by industry A are resources that could have been, but aren’t, used by industries B, C, and D. By intentionally overriding the market’s price, profit, and loss signals, industrial policy – guided chiefly by political exigencies – is like a blind, lame, and drunk donkey.

A final point: This new paper by Scott Lincicome shows that many of Cass’s factual claims about the current state of the American economy are mistaken.

Sincerely,
Donald J. Boudreaux
Professor of Economics
and
Martha and Nelson Getchell Chair for the Study of Free Market Capitalism at the Mercatus Center
George Mason University
Fairfax, VA 22030

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