The Political Economy of Industrial Policy.

Hemphill, Thomas A.

Industrial policy remains an unresolved topic of international public policy and academic debate. In this adaptation of his doctoral dissertation, Professor Chang contributes important theoretical underpinnings and empirical support to an industrial policy discussion which has long been deficient in a modern conceptual and analytical foundation.

The book, organized into four parts, begins by reviewing the theories of state intervention under the four major theoretical groupings of the market-failure, contractarian, political economy and government-failure literature. Chang offers a comprehensive synopsis of each grouping: he begins with the viewpoint of public goods, non-competitive markets and externalities (market-failure); then proceeds to the morality of paternalism and contractarianism (contractarian); continues on to the approaches of the autonomous state, interest-groups and self-seeking-bureaucrats (political economy); and closes with a discussion of the information problem and rent-seeking (government-failure). He asks two difficult questions: Does the state really serve the public interest? And can it achieve what it sets out to do? In answering the first question, Chang suggests that establishing a reasonable set of hypotheses concerning the objectives of a particular state requires firstly, looking more carefully at the process of interest group formation and collective action, and secondly, evaluating the operation of the bureaucracy in the particular state system of political economy. The government-failure literature attempted to answer the second question. However, says Chang, the information problem and rent-seeking is remedied only through non-intervention, leaving a disingenuous choice of failing markets as a superior alternative to failing governments.

In the second chapter, a new institutionalist theory of state intervention is developed. Traditionally, new institutionalist economics, especially the transaction-costs branch epitomized in the work of Ronald Coase and Oliver Williamson, has emphasized the theory of the firm, contracts and the proposition that the market is not the only viable coordination mechanism. Chang extends this work by interpreting the costs of state intervention as transaction costs. His theory of state intervention views the state, the market, the firm and other economic institutions as equally viable coordination devices. The state may reduce coordination costs lower than the market cost through such mechanisms as an effective property rights system, macroeconomic stabilization and coordinating complementary investment decisions. His theory considers the costs and benefits of state intervention, in contrast to the market-failure approach which is oriented to benefits and the government-failure approach concentrating on costs.

In the third chapter, Chang applies his theory of state intervention to the issue of industrial policy and identifies the economic, political and institutional conditions under which it may work. Chang defines industrial policy as "a policy aimed at particular industries (and firms as their components) to achieve the outcomes that are perceived by the state to be efficient for the economy as a whole [p. 60]." This definition is devoid of the "overloaded" tendencies that many other definitions of industrial policy exhibit. Chang's case for industrial policy is anchored in the economic theory of new institutional economics which incorporates the issues of institutional diversity and technical change. Where asset specificity and interdependence are of importance, says Chang, industrial policy can be a coordinating mechanism which is unlikely to possess high bargaining or information costs (unlike the market or central planning regimes, respectively). Additionally, industrial policy promotes technical change by not adversely affecting the profit motive (unlike central planning) and promotes changes that the market cannot engender on its own (through the acceptance of public risk). Chang does recognize that industrial policy has its examples of success, e.g., Japan and South Korea, and failures in Latin America, Asia and Africa where costs have exceeded benefits. The real question, says Chang, is not if industrial policy can work, because the evidence reveals that it does, but how it can be made to work consistently.

The fourth and final chapter evaluates South Korea - according to the author, a successful example of industrial policy. Using comparative time-series data to bolster his thesis of successful state intervention, Chang argues that the rapid economic development exhibited by South Korea in the post-war period owes much to industrial policy. However, the South Korean government has by no means discounted the power of the market. Rather than emphasize allocative efficiency, the South Korean state has taken a dynamic view of the market recognizing market inadequacy in bringing about non-marginal change in late-developing economies. Consequently, the state has concentrated its resources on the problems of technical change and learning. Chang also attributes the success of South Korean industrial policy to other historical, political and institutional factors such as the cultural and ideological homogeneity of the society, the Confucian tradition, an elite bureaucracy, and the state's control over the financial flows of the economy.

Chang's offer of a theory of state intervention with the market sharing equal footing with the state, the firm and other economic institutions is a radical assumption for most capitalist economies which espouse market superiority as the primary mechanism for efficient resource allocation. He does, however, provide a strong case for his final conclusion - "that different countries facing different conditions can, and should, have different mixes of the market, the state and other institutions [p. 135]." But this holds true only where the political process cannot capture it for private rather than national interest.

While the issue of industrial policy has been most heatedly discussed in the United States (where opposition has traditionally stymied its widespread public policy usage), Chang gives only passing reference to the world's largest economy's experience with it. Yet even in the United States, the 1990s have witnessed a "stealth" industrial policy emerging in the latter part of the Bush administration and continuing in the Clinton presidency. This has appeared in a national technology policy that emphasizes investment in research and development, for example, in a new supercomputer, and information diffusion manifested in the "information superhighway." Additional studies on more recent experiences with industrial policy practiced in western capitalist countries may eventually provide further proof of Chang's conclusion.

Thomas A. Hemphill New Jersey Department of Environmental Protection