Industrial policy today:

What it is and how to do it

Charles F. Sabel

Industrial policy today

• What is industrial policy?
• Why is it needed now?
• How is today’s industrial policy different?
• What principles structure the role of government, the private sector and civil society in modern industrial policy?
• How can today’s industrial policy be institutionalized?

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What is industrial policy?

• Industrial policy refers to those measures that redirect economic activity to solve urgent social problems such as decarbonizing the economy, accelerating economic growth or achieving shared prosperity that the market, left to itself, will not address.
• You can think of industrial policy as a set of incentives embedded in regulations, the tax code, or special programs that encourage firms and other actors to take risk and engage in forms of collaboration that would not be justified by normal investment criteria.
• Note to nerds: If a social planner—the astute politician—knew exactly how actors would react to incentives, and how much of good, like pollution reduction, is needed for public purposes, the market’s failure to price negative or positive social externalities could be corrected by a Pigouvian tax or subsidy. But the social planner can’t have the needed information. So she uses industrial policy instead.

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Why industrial policy is needed today

• From the 1990s until recently the green transition was seen conceptually as a matter of marginal adjustments—reducing pollution—to be achieved by taxing carbon or related cap and trade systems.
• Increasingly the realization is that greening the economy means reinventing fundamental parts of it—what a car is, how to produce steel and concrete, how crops are grown—and that such changes will reach deep into the fabric of everyday life, disrupting the way we work and live.
• The market will not produce the innovations we need to decarbonize—we know how to produce dirty technology. It is much cheaper, and much less risky, to produce the next generation of dirty than the first generation of clean.
• Experience has taught that we cannot leave the complimentary adjustments at the local level to the normal interplay of market and political forces.
• These changes must be accomplished deliberately, through some version of industrial policy, or at enormous cost, if at all.

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Changing view of the green transition is a case in point

Industrial policy then and now

• Industrial policy has traditionally been used by developing countries to establish a bridgehead in industries from which dominant pattern of trade and technology flow excluded them.
• Since the aim was to master production of goods such as textiles, garments or steel already in worldwide commerce, the nature of the technology, the regulations governing the use of the good and conditions of trade were all known.
• To master production it was necessary to protect infant industries from competition until local producers learned to compete.
• This strategy produced many notable successes (East Asian, the Nordic countries, etc.).
• But it sometimes led to rent seeking, and in its most current form—the strategy of attracting foreign investors rather than building national champions—it can produce enclave economies.

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Then—infant industries and FDI

Industrial policy today

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Modern industrial policy directed to innovation at the frontier of knowledge

• Neither the technology of the product or production process, nor the regulations governing both nor the conditions under which they will be traded can be taken for granted.
• On the contrary: technology, regulations and trade conditions all have to be continually adjusted to encourage the innovations needed.
• This mutual adjustment in turn requires close and continuing collaboration among (shifting) groups of producers, between them and the government, and within the government between regulators with overlapping jurisdictions and between those regulators and trade officials.
• While the ambitions of industrial policy remain fixed, its interim goals must be continually revised to encourage innovation within the realm of the feasibility—or if you like, to find the possible steps to the impossible.

Industrial policy is an important case of decision making under uncertainty

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• A classic definition of uncertainty contrasts it to risk—under risk the states of the world can be assigned probabilities reflecting how likely they are to occur.
• Under uncertainty outcomes are unknown, and can’t be described probabilistically.
• A working definition of uncertainty is the condition in which experts disagree, or go silent.
• Since modern decision theory assumes all possible outcomes can be ranked by comparing their benefits or costs weighted by the probability of their occurrence, uncertainty might thwart rational decision making—all we can do is throw darts.
• But under uncertainty the way to make rational decisions is to learn as rapidly what is feasible, advancing the horizon of possibility as one discovery enables the next.
• In this sense modern industrial policy is an institutionalized process for learning in the face of uncertainty.

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• Monitoring is diagnostic—the aim is to catch problems early, before failure cascades.
• Ground level actors, with direct knowledge of and often a say in project development, report progress and prospects regularly.
• Evaluation is by peers from a variety of disciplines but all experienced in the kind of projects under review.
• Continual monitoring makes it possible to redirect or halt projects that encounter currently insuperable problems, or dedicate additional resources to promising efforts.
• Thus projects can be transformed in the course of being “executed” yet all the while accountable for the decisions they make.

Continual monitoring—the key to rapid learning and accountability under uncertainty

Foundations of modern industrial policy

• Modern industrial policy uses technology-forcing regulation to induce actors to do the (currently) impossible by getting them to stretch, again and again, the limits of the possible.
• This means setting ambitious goals—getting to net zero by 2030 in some domain—and then setting more and more demanding interim goals as the search for solutions reveals new possibilities.
• Given the regulator’s commitment to act, inertia no longer favors the status quo. Since a rule is coming, the actors with most confidence in their improvement strategies consult with the regulator in an effort to have their preferences incorporated into the rule, minimizing their own costs of adjustment and raising the costs to competitors with different approaches. And if one actor cooperates with the regulator, others will too, for fear of being left out, to get a hearing for their solutions and to learn what competitors are up to.
• This broad participation ensures that the regulator’s decisions to set and correct goals are well informed and the traditional information asymmetry between regulator and regulated entity—the entity knows the costs and prospects of mitigation and the regulator does not—is at least in part overcome.
• Laggards will stay on the sidelines as the standards are set. Once they see that compliance is feasible, many will consider bringing themselves into line, but will have trouble implementing and perhaps even fully understanding the adjustments that are needed.

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1. Regulation is deliberately corrigible, or Technology forcing regulation

Foundations of modern industrial policy

• Normally incentives are calculated so that the penalty just exceeds the value of the likely infraction. Under uncertainty those costs and benefits can’t be assessed.
• Instead the incentive takes the form of a penalty default imposing a binary choice: pursue the best, feasible alternative to the status quo given your situation, with support if necessary, or suffer a prohibitively costly outcome—exclusion from the market.
• For capable actors, who stand to benefit from demanding standards, the best alternative to pursue improvement in the desired direction, frequently in collaboration.
• For laggards the best, feasible alternative to the status quo is likely to be a renewed effort to catch up, but with the help of various technical and financial support programs.
• The penalty default then actually applies only to actors that won’t or can’t improve.

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2. Incentive uncertainty, or penalty defaults

Foundations of modern industrial policy

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3. Under uncertainty capacity-building services matter

• The more uncertain the situation the less actors know what to do or how to do it.
• Subsidies alone will not enable actors to do what they presently can’t; nor will penalties dissuade actors from violations they cannot by best efforts avoid.
• Industry leaders therefore will often have to collaborate with each other, and with specialized research institutions to solve the problems before them.
• Laggards will often need the help of extension services to meet minimum standards and generally remain competent in rapidly changing markets.
• To repeat—the same uncertainties that make Pigouvian taxes and subsidies unworkable as a solution to unpriced externalities make corrigible, technology-forcing regulation, penalty defaults and extensive service provision the core of modern industrial policy.

Institutionalizing modern industrial policy

• The ground level of industrial policy consists of tables or cluster organizations which convene and help identify the actors and their shared problems in a particular industry and (where the industry is wide-speak) particular place.
• But the tables’s role is not limited to convening and mapping. It has an operative role as well as a front-line problem solver, establishing working committees to propose solutions to problems as they are identified
• Typically representatives of research hubs, described next, participate in the meetings, working groups and governance organs of the tables, and vice versa.
• One example of a successful cluster organization that could become a problem-solving table is the Quebec propulsion organization.��

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Tables, research hubs and government

Research hubs and extension services

• Research hubs perform a double function.
• First they bring current domestic and international knowledge from industry and academia to bear both on concrete common problems, large and small, identified by the tables, or particular to individual firms.
• In addressing these problems the hubs naturally extend and depend the space for collaboration within the cluster, bringing engineers and business people to share a sufficiently common perspective so that joint work is less daunting, if not natural.
• The hubs are also an important voice of the tables in setting national research priorities and in the fora elaborating domestic and international standards.
• A model for these research hubs might be the German Frauenhofer-Gesellschaft.

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The private sector

• Whether for their own behalf or acting under contract for the public sector firms will be responsible for conceiving many and executing almost all projects.
• It therefore goes without saying that their active participation in the tables, and their working committees and governance, as well as in the activities and governance of the research hubs is indispensable.
• Note that the continual monitoring and peer review at the heart of rapid learning under uncertainty is second nature to firms in the knowledge economy: Constant revision of interim target as steps to ambitious goals is at the heart of familiar disciplines such as just-in-time production, simultaneous engineering, rapid prototyping, precision agriculture or services as products (and products as services).
• From this perspective industrial policy reinforces the forms of organization that make the economy competitive.

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Government

• Regulators (may) have to learn to structure and keep abreast of continuing discussion with private sector actors and civil society of emerging possibilities. Since standard setting will both incentivize the behavior of innovators and guide the actions of followers coordination among regulators with overlapping functions with (the different levels of) government and between them and the private sectors in a key to success. Regulation in turn will have to be more closely linked to trade policy so that domestic incentives are not undercut by the menace of non-complying imports.
• Budget authority—foundation endowment and conditional allocations. Tables and research hubs are endowed with sufficient resources for institutional stability. Additional allocations depend on project or agenda specific proposals evaluated against competitors at regular intervals during the fiscal year.
• Above all the government, not less than other actors, will have to build the capacity to make close collaboration with the private sector and civil society truly serve the public good.��

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Modern industrial policy might be most challenging for government

Thank you