Making Industrial Policy

Economies are like bicycles. The faster they move, the better they maintain their balance unaided. An economy experiencing rapid growth can adjust with relative ease to changes in supply, demand and technology. Workers whose jobs are threatened because of new products, shifts in consumer tastes, or automation can find new jobs; communities whose major industries are failing can attract new industry; and firms whose products are becoming less competitive can diversify into more competitive lines of business. All these adjustments, in turn, help ensure continued growth.

Adjustment is less automatic, however, in an economy growing slowly. Under these circumstances, workers, communities, and firms facing economic changes that erode their competitive position often have no profitable alternative toward which to shift their resources. Because the process of economic change may seriously threaten their future well-being, they turn to political devices designed to stem the tide, at least temporarily: legislation to stop runaway plants, regulations to prohibit the introduction of new technologies, government-financed bailouts. But protections like these retard future economic growth by encumbering the movement of resources toward more productive uses, and the downward cycle perpetuates itself.

Foreign trade intensifies both alternatives. It can make a growing economy even more dynamic-providing domestic firms with a wider range of resources and technologies with which to produce, and a larger market in which to trade, than they could enjoy in a single national economy. The international arena thereby offers opportunities to reduce unit costs far more rapidly than they could be reduced in a single economy, and thus contributes to faster economic growth.

On the other hand, foreign trade can exacerbate the problems of adjustment within a slow economy. Under these circumstances, more rapid growth often takes place in a different nation, to which domestic capital is attracted. Domestic labor is left behind within vast regional pockets of unemployment from which escape is costly and psychologically difficult, while domestic industries that have high fixed costs gradually lose their market share to their foreign rivals.