Matthew Lau: Subsidies don’t work in China. Why would they work here?

Matthew Lau: Subsidies don’t work in China. Why would they work here?

Emulating Chinese central planning will not ensure Canada can either compete with or be protected from China

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That government economic planning is generally unsuccessful is, like the doctrine that demand curves slope downward, so firmly established by experience and observation that it really should be possible to state it without providing supporting evidence. Despite its widespread failure, however, government planning is vigorously practiced and its effectiveness, especially when it is rebranded as “industrial policy” or equivalent euphemism, is asserted in many quarters — including think tanks like the Public Policy Forum and much of the business community.

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In a recent commentary Robert Asselin of the Business Council of Canada continued his incessant beating of the industrial policy drum. Joe Biden’s industrial strategy includes the so-called Inflation Reduction Act (US$499 billion in spending, of which $391 billion is on climate change) and the CHIPS Act (subsidies and protectionism for semiconductors, supposedly to “create jobs” and “counter China”). But Canada, Mr. Asselin writes, is still searching for its own industrial strategy and must find it.

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Criticisms that industrial policy amounts to central planning he dismisses by saying there are national security concerns with leaving everything to the free market. Some national security concerns are indeed legitimate, but the industrial policy he proposes — and the federal government practices — goes far beyond ensuring industries critical to security don’t rely on Beijing or other bad actors. Instead, it extends well into central economic planning. But emulating Chinese central planning will not ensure Canada can either compete with or be protected from China. On the contrary, it will harm Canadian competitiveness.

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Evidence of that is provided by a trio of researchers, two from Carnegie Mellon University and one from Shanghai Tech, whose just-published study on Chinese industrial policy concludes China’s subsidy programs have been a failure. “At the aggregate level,” they write, “subsidies seem to be allocated to less productive firms, and the relative productivity of firms receiving these subsidies appears to decline further after disbursement.” Even subsidies for research and development, innovation, and equipment upgrading were not positively associated with recipient companies’ productivity growth.

There is no reason to suppose Canadian industrial policy will fail any less than Chinese industrial policy has. In Canada as in China, government economic planning is an inherently impossible task and guided by political instead of economic considerations. The only difference is that, unlike in China, the main political consideration driving Canadian industrial policy is climate alarmism. Thus Chrystia Freeland has in recent months been criss-crossing the country (though presumably not on a bicycle) pushing her plan for “a real muscular industrial policy, a government committed to investing in the green transition,” a plan echoed in her fall economic statement last month.

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The federal government is now, according to news reports, getting set to “transform its industrial policy” by entering into an electric-vehicle subsidy war with the United States. Unfortunately, as in a trade war, governments in a subsidy war end up shooting at their own citizens. The effect of industrial subsidies is to reward and encourage economically unproductive behaviour by taxing and discouraging productive activity. Even so, Robert Asselin praises the federal government for making “important strides” on electric vehicles, his main criticism apparently being that even more central planning is needed. “Subsidies to companies in one sector,” he says, “is not a comprehensive industrial strategy.”

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But as economist and political scientist Michael Munger argued in a September 2022 article in the Journal of Law, Economics and Policy, good industrial policy is not only unlikely but impossible. There is first the information problem: economic knowledge is decentralized, so centralized economic planning sits on a foundation of ignorance. There is then the incentives problem: in Canada and the United States, as in China, even if government officials had all the information necessary to identify what is in the public interest, they are likely to act in their self-interest instead. This application of basic economic assumptions to political decision-making is known as public choice. All industrial policy advocates need do, Munger suggests, is read basic public-choice theory, “and we would stop hearing about all this nonsense.”

The end of nonsense does seem unlikely, however. After all, there are still people — some advocates of raising the minimum wage, for example — who deny that demand curves do slope downward. Still, some understanding of public choice and basic economics would at least reduce the amount of industrial policy nonsense we hear. Better yet, it might even reduce the amount of nonsense the federal government can get away with instituting.

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