http://www.economist.

com/node/16743343

The state and business

Leviathan Inc

Governments seem to have forgotten that picking industrial

winners nearly always fails
Aug 5th 2010

LISTEN carefully, and you may detect a giant sucking sound across the rich world. In the 1990s
this was the sound protectionists in the United States thought (wrongly) would accompany jobs
disappearing to Mexico as a result of a free-trade deal. This time, too, there are big worries about
jobs and growth, but the source of the noise is different, and real enough: it comes from the
tentacles of the state, reaching into more and more areas of business in an effort to get the
economy moving. It is the sound of Leviathan Inc.

Politicians are reviving the notion that intervening in individual industries and companies can
drive growth and create jobs (see article). It is not just the usual suspects—although it is true that
France, the land of Colbert, is busy taking stakes in toy manufacturers, video-sharing websites
and fallen national champions. Elsewhere in Europe, from Berlin to Brussels, demand for
industrial policy is back. Japan’s new government is responding to what it sees as the
increasingly aggressive policies of foreign competitors by deepening the links between business
and the state. In America Barack Obama, the effective owner of General Motors and a chunk of
Wall Street, has turned his back on the laissez-faire approach of the past: a strategic-industries
initiative is under way.

Although an understandable panic over economic growth in the rich world explains much of the
state’s new meddling in business, other forces are at work as well. After the finance and property
bubbles some influential companies—such as EADS and Rolls-Royce in the aerospace
industry—are pressing for policies that support manufacturing. Bail-outs and billions of stimulus
spending, however justified at the time, got government back into the habit of intervention. The
case of Fannie Mae and Freddie Mac, America’s housing-finance giants, illustrates both the
perils of state meddling (implicit state guarantees distorted the mortgage market with fatal
consequences) and the difficulty of giving it up: having rescued the pair, the federal government
lacks any plan to pull out.

And Western politicians cannot fail to be influenced by the success of emerging countries like
Brazil, India and China, where a big role for the state in business seems to be working wonders.
Nine of the world’s 30 largest listed firms are emerging-market companies that count the state as
their dominant shareholder. In the 1980s, the last time industrial policy was in fashion, the West
was in awe of Japan and its inexorable rise; now it is in awe of China and its state capitalism.

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Déjà voodoo

Yet the overwhelming reason for China’s miracle is that the state released its stifling grip and
opened the country to private enterprise and to the world. The likes of Li Shufu, who runs Geely,
the car firm that has just bought Volvo (see article), are entrepreneurs, not bureaucrats. India’s
wildly successful software and business-process-outsourcing industries blossomed not because
of help from the government, but precisely because its Licence Raj did not understand these
nascent fields well enough to choke them off. In Brazil, where it is often said that an activist
industrial policy helps to explain why the economy has been thriving, a surging state-owned
development bank, BNDES, is probably crowding out other sources of finance (see article). The
likes of Petrobras (oil), Vale (mining) and Embraer (planes) were indeed created by the
government. But they have all flourished because they were privatised, to a degree, and forced to
compete with foreign firms in the 1990s. Part-privatisation and competition created in a short
time what decades of industrial policy had failed to do.

In the rich world, meanwhile, the record shows, again and again, that industrial policy doesn’t
work. The hall of infamy is filled with costly failures like Minitel (a dead-end French national
communications network long since overtaken by the internet) and British Leyland (a
nationalised car company). However many new justifications are invented for the government to
pick winners, and coddle losers, it will remain a bad old idea. Thanks to globalisation and the
rise of the information economy, new ideas move to market faster than ever before. No
bureaucrat could have predicted the success of Nestlé’s Nespresso coffee-capsule system—just
as none foresaw that utility vehicles, vacuum cleaners and tufted carpets (to cite examples noted
by Charles Schultze, an American opponent of state planning) would have been some of
America’s fastest-growing industries in the 1970s. Officials ignore the potential for innovation in
consumer products or services and get seduced by the hype of voguish high-tech sectors.

The universal race to create green jobs is the latest example. Led by China and America, support
for green tech is rapidly becoming one of the biggest industrial-policy efforts ever. Spain,
blinded by visions of a solar future, subsidised the industry so lavishly that in 2008 the country
accounted for two-fifths of the world’s new solar-power installations by wattage. This week it
slashed its subsidies, but still has a bill of billions.

How to keep the beast at bay

Not all such money is wasted, of course. The internet and the microwave oven came out of
government-led research; the stranger stuff that governments do can prove surprisingly
successful. A few governments, such as America’s and Israel’s, have contributed usefully to the
early development of venture-capital networks. Some advocates of industrial policy argue that
the government, like a pharmaceutical company or a seed-capital firm, should simply increase
the number of its bets in order to raise its hit rate. But that is a cavalier way to behave with
taxpayers’ money. And the public funds have an odd habit of flowing towards politically
connected projects.

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Fortunately, there are now some powerful constraints on governments’ ability to meddle. In an
age of austerity they can ill afford to lavish money on extravagant industrial projects. And the
European Union’s competition rules place some limits on the ability to do special favours for
particular firms.

That points to the first of three ideas that should guide a more sensible approach to securing the
jobs of the future. Straightforward steps to improve the environment for business—less red tape,
more flexible labour markets, simpler tax and bankruptcy regimes—will be more effective than
handouts to favoured firms or sectors. Europeans ought to be seeking to strengthen the rules of
their single market rather than pushing to dilute them; a long-overdue single European patent
process would be a good start. Competition will do far more for jobs than coddling.

Second, governments should invest in the infrastructure that supports innovation, from
modernised electricity grids (a smarter way to help green energy) to basic research and university
education. The current fashion for raising barriers to the inflows of talented researchers and
entrepreneurs hardly helps. Third, rather than the failed policy of picking winners, governments
should encourage winners to emerge by themselves, for example through the sort of incentive
prizes that are growing increasingly popular (see article).

None of this excites politicians as much as donning hard hats and handing out cash in front of the
cameras. But the rich world has a clear choice: learn from the mistakes of the past, or else watch
Leviathan Inc grow into a true monster.