Industrial Policy: Redux or Renewal? - Opening remarks by Governor Gabriel Makhlouf at the Centre for Economic Policy Research–UCD–Central Bank of Ireland workshop

The Return of Industrial Policy: Historical Lessons and Contemporary Challenges

Introduction

Good morning everyone.

It’s a pleasure to open this workshop, and a particular welcome to those of you who have travelled to be here.

It’s probably helpful, in opening a workshop on the subject, to be clear about what I – and I think most economists and policymakers – mean when I use the phrase “industrial policy”.  To me, it means a policy targeting specific firms or sectors, with the goal of changing the composition of economic activity in the economy through government action rather than leaving it to the market.  “Industrial” is something of a misnomer, as this definition applies just as naturally to service sectors and firms as it does to manufacturing ones.

For many decades, industrial policy was almost a taboo subject in economic policymaking.  But, as so often with taboos, it was practised and in plain sight, by the US and China to name but two examples.  The sense of a taboo reflected the dominance of the power of free and efficient markets in economics – Gary Becker’s view that the best industrial policy was none at all is well known – but the evidence in favour of something different has been mounting and the need for careful and more nuanced analysis is now too strong to resist.  For example, in the early 1980s Paul Krugman was an industrial policy sceptic, arguing that nobody had good criteria for choosing which industries to support: governments couldn’t pick winners, spillovers were hard to identify and favouring a particular sector invited capture by special interests.  He has now come round to the view that some limited industrial policy is worth engaging in, because of positive spillovers between technology firms but also because of geopolitics.

To put it another way, the reformation has nailed its theses to the door of economic debate and the taboo is no more.  This is perhaps most dramatically exemplified by the World Bank’s recent Policy Research Report which takes a completely different stance to its own view 30 years ago.

I want to use my opening remarks this morning to set out why I think we are seeing this resurgent interest in industrial policy, and why we should remain both open-minded but also cautious.

And let me start by saying that a gathering like this one, combining both historical and contemporary evidence, is exactly what policymakers need to make informed decisions.

Reigniting growth and competitiveness

Over the past several years the global economy has absorbed a series of large shocks: the pandemic, the energy and inflation shock that followed the invasion of Ukraine, a sharp rise in trade barriers and, more recently, a renewed surge in global energy prices following the attack on Iran.  Those shocks have – for good reason – absorbed much of our attention.  But focusing on the short-term risks crowding-out thinking about longer-term challenges.

One of the most important of these is the slowdown in productivity growth, which has been one of the main contributors to the slowdown in overall economic growth and in living standards since the 2000s.

We’re all familiar with the Krugman quote, from more than thirty years ago, that "productivity isn't everything, but in the long run it is almost everything."

And in this context, Europe has a problem.  Productivity growth has slowed on both sides of the Atlantic, but it has slowed further in Europe.  In the United States, labour productivity growth fell from 2.7 per cent a year between 1995 and 2007 to 1.3 per cent between 2007 and 2019.  In the larger European economies, it fell from 1.3 per cent to just 0.5 per cent.¹

Behind those numbers lie some familiar patterns.  The US invests a lot more in innovation and in the adoption of new technologies than the EU: around 3.5 per cent of GDP on research and development, compared with around 2.2 per cent in Europe.  High-productivity firms in Europe have a harder time scaling-up to be as large as their US counterparts.  And our capital markets remain fragmented and reliant on bank debt, which is rarely well-suited to financing risky, innovative, investment.

These facts were laid bare in the Draghi and Letta reports and explain the renewed emphasis across Europe on so-called competitiveness.  With AI arriving as a new and potentially transformative technology, these concerns have never been more important.

The turn to the industrial policy toolbox

Increasingly, there are voices in Europe arguing that the answer is industrial policy.  Some of that reflects concern about the increasing fragmentation of the global economy along geopolitical lines and the gradual collapse in the primacy of free trade embodied in the WTO and the post WWII framework.

In such an environment, it is not surprising that European policymakers have been focused on developing a broader set of tools in search of “open strategic autonomy” or the EU’s ability to “make its own choices and shape the world around it [building on] the importance of openness [and] the EU’s commitment to open and fair trade”.²

I suggest that, as economists, we should be balanced in our response to this shift.  The historical record of industrial policy is genuinely mixed.  There are episodes where targeted support appears to have helped build lasting capabilities. There are many others where it protected incumbents, steered capital towards politically-favoured firms, and proved very hard to unwind.

A historical lesson that has been learned many times over is that industrial policy can quickly become a large expense for the state.  And it’s clear that, at the current juncture in Europe, fiscal trade-offs need to be made in many countries, and industrial policy is no free lunch.

We have to be clear-eyed on what the best respective roles of the public and the private sector truly are.

There are areas where the state has an inherently large role, such as defence. Economists have also long emphasised the large positive spillovers of the public funding of innovation and R&D.  The wonderful thing about innovation is that ideas are non-rival: an idea developed in Boston or Berlin can raise productivity in Dublin.

If I have a particular worry, it is that Europe turns “open strategic autonomy” into a pursuit of necessary resilience but forgets the word “open” and cuts itself off from the very flows of ideas, capital and people that have driven productivity gains in the past.  Or that we blur the lines between what the role of the state should be and what is best left to the private sector.  In short that we forget the lessons of the past.

Why history matters: the value of this workshop

This is why I think this workshop is so timely, and why this combination of historical and contemporary perspectives is very valuable.

Last year's workshop, which focused on international trade and history, highlighted the importance of looking at historical episodes.  Until very recently, most of the modern evidence on the effects of tariffs came from episodes of trade liberalisation.  To study what happens during episodes of broad-based tariff increases, researchers had to go back almost a century to the inter-war period and Smoot-Hawley.

I think there are many similarities with industrial policy.  Careful study of historical episodes of industrial policy use – what worked, what didn't, and why – is an essential input to decisions being taken now.

At the same time, the world is changing and old lessons do not always translate directly to the modern context.  Bringing the two perspectives together is a very welcome ambition for this workshop.

Ireland's experience

Let me close with a brief word on Ireland, because our own history speaks to many of these questions.  At different periods in its history, Ireland has both tried inward and outward-looking approaches.

From the 1930s to the 1950s, Ireland pursued an inward-looking strategy built on high tariffs and restrictions on foreign ownership, with the aim of building-up domestic industry.  The results were disappointing: weak growth, high unemployment, persistent emigration, and an industrial base that struggled to compete once protection was removed.

From the late 1950s the direction changed towards openness to trade and foreign investment and ultimately membership of the European Economic Community in 1973. This and other reforms, not least the strengthening of Ireland's educational and social policy infrastructure, has led to a transformative change for the Irish economy.³

This openness and the investment in education helped build the skilled workforce and industrial base that has made Ireland competitive in the global economy and attractive to foreign direct investment.  Today, multinational firms employ around a quarter of our workforce, with positive spillovers to the wider economy.  The IDA, Ireland's Industrial Development Agency, has long played an important role in our growth story.

I would draw two lessons.  First, Ireland's policies have worked best when they have been combined with openness and engagement in the global economy.  And, second, investments in education and skills have been highly complementary to our openness to foreign investment.

This is the essence of good industrial policy. For me the State has always been best at providing the foundations and the enabling conditions for private sector innovation and growth, addressing genuine market failures and providing the public goods upon which private enterprise can build in the best interests of our citizens.  Something we must all remember as we look to address the challenges facing our continent and its economy.

Conclusion

To conclude, for a small, open economy such as Ireland, the future of industrial policy, in Europe and more broadly, matters.

Deepening the Single Market – in goods, in services and in capital – will be important in the face of headwinds from broader global economic fragmentation.  Deepening Europe's capital markets in particular could help unlock the almost €12 trillion that Europeans hold in savings and cash deposits for productive investment.

These are policies which can strengthen growth and I believe they have more evidence to support them than many other industrial policies that are often touted.  Closer to home, maximising the delivery of new public infrastructure to address known deficits in key national infrastructure and crowd-in higher private investment will boost the economy’s long-run growth potential.  This would complement growth-enhancing reforms at EU level.

There has never been a better time for evidence-based research to help inform policymaking.

I am sure there will be plenty of food for thought and insights from today’s workshop. 

My own experience tells me that we must ground any response in principles that heed the lessons of the past while looking to the future.  And for me this means:

• An open rather than exclusionary approach: I prefer “resilient and secure openness” over “open strategic autonomy”;
• Fostering innovation rather than favouring certain champions;
• Complementing not competing with the private sector; and
• Being forward-looking rather than trying to preserve the past.

These are what guide me as I think about industrial policy for Europe’s future.

I will leave it there.

Thank you, and I wish you a very productive workshop.