Friday, February 10, 2012

Industrial Policy in the US

Faced with a jobs crisis, the Obama administration is proposing a wide-ranging package of policies to revive the manufacturing sector in the US economy. This interest in reviving manufacturing comes on the back of a three-decade long decline of jobs in American manufacturing - US manufacturers produced roughly the same amount of goods in 2010 as they did a decade before, but they did so with six million fewer employees on their payrolls.

The Times summarizes the proposals which include using taxes, tariffs, and other policies to favor domestic manufacturers over their foreign competitors,

The administration has put together a far-ranging set of proposals: cutting taxes for manufacturers that produce goods in the United States, taking away tax breaks for businesses that move jobs offshore, doubling a tax deduction for makers of high-tech goods, providing support to businesses investing in areas where factories are closing, expanding worker training programs and creating a new task force to better enforce trade rules and intellectual property rights. Closing a loophole that allows companies to shift profits abroad would pay for the tax credits.

This is classic industrial policy. However, instead of directly picking winners, the government is putting in place a framework which would enable the most competitive firms in particular sectors to flourish and develop strength. The ultimate objective of the policy is to increase local job creation and boost economic activity in manufacturing sector.

The big challenge for governments pursuing industrial policy are three-fold. One, which industries (within manufacturing) to favor with industrial policy? Two, what should be the type and extent of industrial policy instruments deployed to support each industry? Three, the need for sunset provisions so that the concessions and preferential policies are not permanently baked in.

It is a very real danger for governments to be misled into either supporting inefficient and flagging industries or deploying the wrong set of instruments (eg, like ones that discourage foreign technology transfers) under pressure of lobbying from industry interest groups. This is all the more a problem in democracies since these industry groups are more often massive contributors to the political parties. The difficulty faced by the Government of India in withdrawing the tax concessions granted to IT firms operating within the software technology parks established by the government is a classic example of the problems with exiting such policies.

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