The Rediscovery of Government Industry and Active Investment Policy for a Sustainable Future – Where Does Europe Stand in the Global Policy Competition?
Starting point
Industrial policy was long viewed as anathema. After the concept of ‘industrial policy’ was first politically and then academically discredited during the 1980s it became virtually impossible to make the political case for it. In the torrent of radical pro-market currents of thinking the idea that markets required social underpinning as well as political signals and interventions was branded as out-dated thinking. The argument went: why should political players know more than market actors when we're talking about viable and sustainable structures of production. ‘Picking winners’ became synonymous with state interventions that inevitably produced market disruptions and misallocation of resources.
In the words of the German Council of Economic Experts:
Whenever structural transformation can be seen and technological changes loom the calls for industrial policy interventions get louder...Often these calls get coupled with pointers to the supposedly successful industrial policy of other states...To be lastingly successful, however, an innovation hub should abandon any directional industry policy that views it as a government task to single out markets and technologies of the future as strategically important...It is unlikely that politicians possess reliable knowledge and expertise about future technological developments.
In economic theory it's hard to justify it but the concept behind industrial policy of market failure is very well-established. From as far back as articles on information theory in the 1970s we know that so-called asymmetric knowledge-possession can lead to erroneous choices with the result that the famous ‘markets for lemons' can hold sway: less ‘good’ products and services leave no place for ‘better’ offers. This implies that economies may exhibit suboptimal structures of production because not all potential innovations are activated.
It is also rightly and empirically – as well as theoretically – well-established that markets and market actors in capitalist systems generate an enormous dynamism and rapid technical progress. Market-driven sectoral change is unquestionably the mark of a capitalist regime. This dynamic is, of course, no guarantee of either a stable and sustainable growth path nor of socially acceptable sectoral change. And this dynamic provides no automatic guarantee that market economies will benefit in the same way from it. In an analytical perspective there is a lot to be said therefore for industrial policy interventions by the state.
One cannot dismiss out of hand all political objections to government industrial policy. It is well-known that industry policy may hold up as well as foster structural change, especially when it takes the form of maintenance subsidies. A well-known example is shown by the widespread subsidies for fossil fuels that prevent climate-friendly structural change to zero-emissions forms of energy. If you define industrial policy as encompassing all state interventions in sectoral change then there is good reason why industrial policy (i) is used everywhere as an economic policy tool and (ii) is relevant as a political market intervention. This is especially true when it comes to the field of innovation policy where, for example, the Anglo-Italian expert Mazzucato has demonstrated empirically that government activities played a critical role in the formation of innovative products and processes. It's also theoretically valid that specific types of innovation that are of net social benefit are rather sub-optimally market-generated. Government interventions in the cost-benefit analysis of private sector innovative processes may help avoid such under-production. What's more, government innovation policy may set the direction of innovative processes which is becoming ever more important in conditions of global technological competition.
In an earlier essay I argued that industrial policy may well have had a bad reputation but, practically and empirically, it remains the case today that all economies practise one or another type of industry policy. This also holds true in a European context for the European Union (EU) which has been given stand-alone industrial policy competences under the Maastricht Treaty. Explicitly mentioned is ‘strengthening the competitiveness of the Community's industry’ and, in one of the many communications of the European Commission on industrial policy in conditions of globalization and technological change, it is stated:
It is essential to increase productivity in manufacturing industry and associated services to underpin the recovery of growth and jobs, restore health and sustainability to the EU economy and help sustain our social model. Industry is therefore at centre stage of the new growth model for the EU economy as outlined in the Europe 2020 Strategy.
Of course, the EU and its member state economies are miles away from a socially and economically sustainable growth model.
Innovation race
Industry policy may be anathema in market liberal circles but, empirically, it goes without question that this tool is widely used. In one form it is defensive, where the question is to stop or at best delay technology-driven sectoral structural change. A current example is the Trump Administration's support policy for coal in the USA and even the pit-closure program in Germany can come under this heading. The prime aim here is to protect established industries and preserve jobs even if the economic fundamentals have actually rendered these sectors obsolete.
In another form there is a type of offensive industrial policy. Here it is about seeking out, in a period of risk and uncertainty, new fields of technology, fostering them and generating likely new sectors and employment relations. This type of policy can offset market failure by supporting technologies whose potential social rate of return is above the private equivalent. What's more, an offensive industry policy can propagate fields of technological application that are rated as too insecure and risky at any given point by the private sector. And, finally, industrial policy also includes the active identification and promotion of basic innovations and related potential product and process innovations.
Especially in a period of far-reaching technological upheaval, markets need specific incentives and settling-in measures to quit the old growth paths and switch to new ones.
That kind of constellation exists today. Borne by so-called General Purpose Technologies (GPTs) and propelled by new business models, processes have been activated that are devaluing established segments and products and introducing new production standards as well as products and services. The huge pressure to adapt and change generated by GPTs places demands on the business sector to show the capacity and willingness to grasp market opportunities and bring the required organisational changes and, above all, creativity to bear in embracing transformative technologies. By definition GPTs have a huge potential for application and exploiting this potential to the full is what counts. Defensive industrial policy cannot promote such change. Offensive industrial policy, on the other hand, must connect much more strongly with the movers of innovation policy and thereby promote intelligent specialisation profiles. Market actors alone, the thesis runs, cannot manage such change either sustainably or in a socially and ecologically acceptable manner. In economic policy praxis it's mostly about ensuring top spots in the global innovation race and not about the transition to sustainable growth paths.
Europe's position in the global innovation race can best be described as mixed. If you consult, say, the Global Competitiveness Index of the World Economic Forum (WEF) that gives weightings to different institutional and politico-economic factors that help determine the development of productivity, then you'll find straightaway 11 EU economies among the top 25; then a dozen EU member states in the following rankings (26-50), including as big an economy as Italy's at 31st. In its 2018 report the EU's Innovation Scoreboard concludes that the EU as a block occupies 6th place after South Korea, Canada, Australia, Japan and the USA. It is also stated there that the EU is losing its relative advantage in innovativeness vis-à-vis China – starting from a low level. The picture is further mixed in so far as there are big intra-EU differences with regard to innovativeness. Behind a small group of Innovation Leaders (Sweden, Denmark, Finland, The Netherlands, Great Britain and Luxembourg) comes a group of Strong Innovators (Germany_,_ Belgium, Ireland, Austria and France). Around a half of member states rank as Moderate Innovators, with Bulgaria and Romania bringing up the rear. This heterogeneity appears to be a structural feature of the European economic space and points to the exclusive character of its economic model: A small number of economies is institutionally ready to take on innovation opportunities while a bigger number lag behind the innovation train.
This discrepancy reflects the specialization profile of a national economy and, herewith, the way it is integrated into the international/European division of labour. European innovation laggards are mainly enmeshed in supply chains that do not serve to promote autonomous efforts in innovation. Overall it is the case, however, that EU economies operate within the middle technological area and, within that, exhibit in international terms the highest R&D expenditures (as a share of GDP) after Japan. In regards to high-tech sectors, the EU already is behind China as the EU R&D scoreboard from 2017 shows.
This traditional strength is no longer sufficient in an era of rapid technological change to keep up in the international technology race, as the European Commission declared in 2018:
…compared to their non-EU counterparts, EU companies outperform or perform comparably in size (of R&D and sales) and R&D intensity (ratio of R&D to net sales) for Aerospace & Defence, Automobiles and Pharmaceuticals. But in Biotechnology, Software and IT hardware the EU shows persistent weaknesses in most indicators. The EU gap in these three sectors has widened over the last 10 years.
These findings can be somewhat refined if one disaggregates the data further and looks at company level. Here, for a long time, one can see a high degree of concentration of R&D in a small number of firms whose leadership position is admittedly contested and indeed overwhelmingly by newly emergent technology leaders from the USA and China.
It also looks rather poor when it comes to R&D spend within European economies. The EU has, as we know, set itself the target of 3% of GDP but still remains very far from this goal. This is especially worrying given the efforts made by competitors. Japan and the USA out-perform the EU throughout this period and since 2015 China has caught Europe up. Europe is under innovation pressure. How well-prepared is the European economic space to handle technological revolutions and heightened international competition?
Industrial policy profiles
In a Schumpeterian perspective successful technology-driven structural sectoral change requires private investments and disinvestments: creative destruction. The role of government industrial policy is to stimulate and accompany both processes while withdrawing support from no longer competitive sectors and offering it to emergent processes. But, first and foremost, it is market-induced private sector investments that feed capital accumulation and drive forward the modernization of production processes. Investment decisions are always ones whose effects reach into the future and, accordingly, are influenced by today's expectations. In 'normal' periods these expectations are little more than updates of the most recent past. But that is not true in times of technological upheaval and economic uncertainties. It is hardly surprising then that, in the wake of the global financial crisis, investment ratios in terms of gross fixed asset investments against GDP went backwards. For the EU-28 the rate of investment on average during the period 2000-2009 reached 21.9% before falling back between 2010 and 2014 to 19.7% – and by 2018 it had not reached the level of the pre-crisis period (at 20.5%).
Stagnation of the ratio of private investment is, to put it cautiously, unhelpful for accelerated structural sectoral change. Political initiatives such as the European Fund for Strategic Investments ('Juncker Plan') start off at this weak spot without developing any momentum, not least because of a lack of focus on core sectors. Strengthening European industry's competitiveness did not just start as an economic mission with the Juncker Plan. Back in 2010 the European Commission published the communication ‘An Integrated Industrial Policy for the Globalization Era Putting Competitiveness and Sustainability at Centre Stage’, which promised no less than the revival of competitiveness that was already viewed as in jeopardy. The linked package of measures was then, given its minute success, renewed in 2017 as EU Industrial Policy Strategy:
…in a changing world with increasingly competitive global markets, our industry must adjust and adapt to remain ahead of the curve. This requires modernisation: embracing digitisation and technological change, integrated products and services, the development of less polluting and less energy-intensive technologies, the reduction of waste and investments in a workforce with the right skills.
Such goals are easier to put in words than to realize. In the end, reaching them rests on national sectoral structures, the pace of sectoral change and actual innovation capabilities. National economic structures and policy are more relevant here than EU programs, including because government policy has more competence and, above all, can mobilize more budget funding. Nevertheless, the industry policy pursued by the EU is not without significance. Industry policy in Europe can most appropriately be described as a specific form of multi-layered policy in which programmatic initiatives and interventions from the EU, national governments and sub-national bodies such as federal states, territories, provinces and so on can be brought to bear. If coordinating these various levels proves successful, then EU initiatives can indeed generate the right kind of impetus. But this coordination cannot come about automatically, including because national industrial policies vary a lot. Aiginger & Sieber (in The Matrix Approach to Industrial Policy), for example, on the basis of four industrial policy instruments (subsidies, tax incentives, regulations, innovation support), distinguish six industry policy clusters. A cluster of small northern countries (Sweden, Finland, Denmark); a cluster of big mainland European countries (Germany, France); a cluster of small mainland European countries (Belgium, Austria, the Netherlands); a cluster of peripheral southern European countries (Spain, Portugal, Greece) and one consisting of Great Britain and Ireland. One might add a seventh cluster of catch-up east European countries. Each of these clusters has its own quite specific toolbox and is connected to EU programs very much in its own way. This makes it correspondingly hard to speak of one European industrial policy. And there are variants within each cluster. Thus, French industrial policy for a long time had a unique selling point in its focus on national champions. It might be exaggerated to speak of French dirigisme and German ordoliberalism as Warlouzet proposes (in Governing Europe in a Globalising World) but it is right that both countries pursued very different concepts of industry policy in the past. In the German variant for a long period tools such as subsidies and direct/indirect tax incentives like innovation support predominated. In France government industrial policy intervenes directly in market activities, including via nationalization, to build up companies that have less potential to dominate the market in key sectors.
This industry policy panorama becomes even more variegated if you include non-European competitors. The US as global technology leader embodies the ideal type of a liberal market capitalism that is essentially governed by the market. Even so, government industrial policy plays a central role, above all through public procurement in the military area as well as targeted support for basic research in selected universities, with the results then taken up by private sector actors thanks to an innovation-friendly financial services environment. Japan and South Korea long pursued a highly active industrial policy in which government ministries directly co-operated with selected firms. In both cases this industrial policy approach has, all the same, retreated in recent years to be replaced by an indirect and increasingly direct support for basic research in which the state takes on a coordinating as well as steering function. China, meanwhile, banks on its centralized state capacities which enable it to set very ambitious goals technocratically and go about them by directly allocating funds. The industrial policy program, 'Made in China 2025', has in mind no less than making China a global technology leader by 2049 and making itself non-dependent on technology imports. 'Made in China 2025' is meant to be the first step and to give the country a leading place in ten key technologies. To reach such targets the Chinese state is opting for a broad palette of technology imports that opens the door for Chinese businesses to cutting-edge technologies.
These various industry policy profiles by and large reflect specific national courses of development that have taken shape over a longer period. Not all of these policy courses prepare one for today's challenges from fundamental technological disruptions and the simultaneous tightening of global technology competition. This holds especially true for the varieties of European industrial policy which still move in established policy channels and pursue defensive rather than offensive strategies.
Outlook
Industrial policy is not only back on the agenda but also practised politically. In the USA industrial policy proceeds under the banner ‘America First’. This project is a combination of radical deregulation, trade policy protectionism and unilateralism as well as selective support for industry sectors such as steel and aluminum and, what's more, upstream activities like coal-mining. This type of industrial policy is predominantly defensive and attempts to protect US interests against foreign competition. In Germany, then again, the Federal Ministry for Economy and Energy has set out a 'National Industrial Strategy 2030' which pulls together strategic guidelines for German and European industry policy. This strategy proposal can most reasonably be interpreted as a French twist since it puts forward a break with traditional industrial policy by looking to promote the formation of national and European champions. With explicit reference to the disruptive character of current technological upheavals and increasingly global technology competition, the goal is to build up the (internationally relatively high) share of industry in German value-creation to 25% and raise it in Europe to 20% by 2030. Industrial and technological sovereignty is meant to be assured primarily by supporting basic innovations like Artificial Intelligence that are critical for the future.
Both forms of industrial policy are designed to improve the competitiveness of the home economy in their own way. The German variety is forward-looking on the whole whereas the American one is much more geared to conserving existing structures. Of course, the 'mission-oriented' version proposed by German economy minister Peter Altmeister does not come without problems. This type of industrial policy demands, according to experiences assembled by Mazzucato, ‘bottom-up experimentation, and learning, so that the innovation process itself is nurtured through dynamic feedback loops and serendipity’. The promotion of national and European champions in this version is not a promising gambit. Sustainability and social inclusion along a new growth-path demand instead a broad-based and deep integration of innovation processes that, so to speak, can be pursued by a wide range of innovative actors. A new economic course devoted to eco-social sustainability may well need an industry policy but also a broad-based policy offensive in areas such as education and further education, fiscal measures, that would support productive and eco-social initiatives and above all, it needs to embrace the voices and encourage the participation of civil society actors.