I have previously opined in this blog that issues such as the exchange rate of the RMB and the size of the bilateral trade deficit are matters upon which have been lavished far too much attention by the US Congress and others (and if I have not made this explicit before, I should have). In terms of the US-China economic relationship and the future of China’s economy itself, a much more important question is the scope and nature of the role of the Chinese government in its domestic economy and international trade and investment.
A central issue facing China’s leaders in this regard revolves around questions of industrial policies and how best to promote innovation in China. I have previously in this blog noted my view that while the US needs to “re-regulate” our financial services industry, China needs to continue to deregulate in virtually all areas. The recent tendency of the Chinese government to continue, or increase, the use of industrial policies in certain industries runs in the opposite direction.
I have also noted that over the long run I believe a greater use of competition, transparency of regulations, strong IPR protection, freer flow of capital, etc. will help China best achieve its goal of promoting innovation. An approach that has government bureaucrats picking winners from the vast array of emerging technologies and companies and nurturing them with government supports and protective policies is a sure loser in my view. Yes, increased competition, etc. will improve the access for foreign companies in the China market, but I happen to believe this is ultimately to the benefit of China.
Having stated these views previously, some friends (and some not-friends) have cited the example of Japan to argue that industrial policies can be successful in propelling a country to the front ranks of technology. In response, I have noted that I think China wants to develop an economy as dynamic and innovative as the US, not Japan, and anyway, outside of autos, how many successes has Japan had in becoming a global leader in industries due to its industrial policies?
With all of this background in mind, I direct readers to a fascinating article in the NYT today (http://www.nytimes.com/2009/05/20/business/20policy.html?_r=1) that examines issues related to industrial policies (in the US and Japan) and assesses its benefits and (substantial) limitations. (Note: When I say “fascinating” I mean it supports my previously stated positions.
One of the very points made in the article is the following:
“…Problems [with industrial policies], [economists] say, are typically byproducts of what economists call “political capture.” That is, an industrial sector earmarked for special government attention builds up its own political constituency, lobbyists and government bureaucrats to serve that industry. They slow the pace of change, and an economy becomes less nimble and efficient as a result.
Economists say the phenomenon is scarcely confined to nations with explicit industrial policies and cite the history of agricultural subsidies in America or military procurement practices.”
I agree with the analysis of US agricultural subsidies and military procurement practices. However, I would note the scope of “industrial policies” in the US (until very recently, as discussed in the article) has been exceptionally limited, even when compared with Western European economies, not to mention China.
To me, continued broad government involvement in the economy and use of industrial policies by China will undermine China’s efforts to develop the dynamic, innovative economy it wants. It will also lead to increasingly sharp trade frictions with the US and other trading partners.
I believe China’s leaders broadly recognize that in a country where the government’s role in the economy is huge the opportunities for “political capture” are also huge (just substitute “corruption” for “political capture” in this sentence). The question is: can those who specifically understand the damaging role industrial policies play in this equation overcome the substantial pressure that well-connected Chinese special interests are already bringing to bear? For the sake of China’s continued economic development and the smooth development of bilateral economic relations, I hope the answer is yes.