SYNOPSIS:

In the early 1980s there was widespread support for a U.S. industrial policy. Economists, however - myself included - roundly denounced the industrial policy enthusiasts.

There is a respectable intellectual case for government intervention to promote some industries, especially those likely to generate important technological spillovers, but seven or eight years ago it seemed unlikely that our government would have the knowledge to pursue a useful industrial policy or he will to avoid turning it into a political pork barrel.

This article represents a partial recantation. I now believe that U.S. interests would be served by adoption of a limited, explicit industrial policy for high-technology sectors. The reason is only to a small extent that I have changed my views about the economics of industrial policy. It is true that even while the general public’s faith in free markets has been growing, economic theory has in recent years moved increasingly away from the kind of models that justify that faith. The real reason that we need an industrial policy, however, is political. It is the only realistic answer to what otherwise will be a growing confrontation with Japan.

This is not the place to recapitulate the endless arguments over how Japan works. Let me simply assert that the widespread perception that Japan plays by different rules from the rest of us is basically right. This is not a moral judgment, a question of what’s right or what’s fair. It is just a statement of fact.

Japan’s market is not open to foreigners in the way that the U.S. or West German markets are open. How much of a problem does the Japanese difference pose for the United States? To defenders of Japan, and to those who believe that a restructured U.S. economy is about to enter a golden age, there is no problem at all. To alarmists, Japan’s challenge is undermining America’s economic prospects. The reality is more mundane. Japan’s difference hurts the U.S. economy, but only a little. The Japan problem is real, but it is not central.

Yet the problem cannot be dismissed. Japan is a great economic power that does not play by the same rules as the other great economic powers. Economically, and above all politically, that is a fact that cannot be ignored. One way or another, the United States has got to find a way of dealing with Japan. There are two extreme views about what to do. On one side are the old-time free traders, who want us in effect to turn the other cheek. On the other side are the bashers, who want us to confront Japan and demand massive change, or else.

For those of us in neither camp, the whole issue is agonizing. The old- time free-trade position seems naive, reflecting neither the realities of Japan nor the political possibilities for America. Yet the basher program does not seem very appealing either. Above all, it is virtually certain to fail in its premise: Japan will not change all of a sudden, and we therefore will be stuck with the “or else.”

My political forecast is that the bashers will more or less have their way, and that the next decade will be one of growing economic nationalism. This nationalism will be expressed in a demand for import restrictions that will hurt our own economy at least as much as they hurt Japan’s.

But this is an outcome that might be avoided if, instead of trying to bully the Japanese into acting like us, we adopt an explicit, but limited, industrial policy. That is, the U.S. government should make a frank decision to subsidize a few sectors, especially in the high-technology area, that may be described plausibly as “strategic,” and in which there is a perceived threat from Japanese competition. I am not at all sure that the actual economic benefits of such a policy will exceed its costs. However, the downside would be limited: federal expenditures of, say, $ 10 billion a year to support industrial research and development consortia would produce at least some benefits, so that even at worst the net cost of the program to the economy would be a few billion a year - that is, less than 0.1 percent of the gross national product.

At the same time, such a limited industrial policy could serve a double- edged political purpose. It could be an answer to those who fear that Japanese strategic trade policy is squeezing the United States out of all the key sectors, and it could provide an incentive for the Japanese to find ways to open up their system, if only to persuade the United States not to subsidize industries that compete with Japanese exports. An on-budget program would be less likely to turn into a pure tool of special interests than a program of import restrictions whose costs consist of higher prices that are virtually invisible to consumers.

I am not advocating some form of “managed trade” - nor would managed trade be an acceptable, second-best alternative to the proposed industrial policy. One of the main purposes of the policy proposal is precisely to provide an alternative to managed trade, with its hidden costs and near-total dominance by interest-group politics. Viewed from the right perspective, then, a limited U.S. industrial policy could be a relatively inexpensive way to cope with the stresses produced by relative U.S. decline and the special problem of dealing with Japan.

This is a safe policy proposal to make, since it seems unlikely that such a clean solutionwill be adopted. Bashers prefer managed trade, perhaps because its costs are less identifiable; politicians prefer it for the same reason; and in the 1990s anything that raises the current budget deficit is avoided whatever its future costs. But I am now convinced that industrial policy is the lesser of several evils.

Originally published, 5.8.90