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12. July 2019
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Armin Mertens

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“Industrial policy is necessary in today’s world.” Interview with Jens Südekum11 min Lesezeit

Arsen Fazlovic interviewed Jens Südekum (Website, twitter: @jsuedekum), “Economist to the Mighty” (FAZ) and Professor of International Economics at the Düsseldorf Institute for Competition Economics (DICE) at Heinrich-Heine-University. Südekum is CEPR Research Fellow, chairman of the Committee for Regional Theory and Policy at the Verein für Socialpolitik (VfS), and former editor of the Journal of Regional Science.

1. To compensate for the end of lignite mining and coal power generation, the German Government has decided to invest 40 billion euros, between now and 2038, in mining areas. Will state-supported battery factories—i.e. industrial policy—save rust-belt regions like the Lausitz?

Possibly. But the money must be used sensibly. In addition to “no-brainers” such as investing in education or better transport links to major metropolitan areas (e.g. the Berlin-Cottbus rail line), this includes the targeted creation and expansion of future-proof industries. In this sense, the Lausitz really does need industrial policy. But “industrial policy” is a vague term: for some it is central planning in disguise and the road to ruin, for others a panacea and the future of economic policy.

2. So what, really, is industrial policy?

I take industrial policy to consist in the intentional and targeted influencing of sectoral production structures. In other words: state support for value creation and good jobs in manufacturing and associated high-value-added services.

A prime example is targeted support for research and development (R&D) in previously defined industrial sectors. This can be used to internalise so-called “knowledge spillovers” via the coordination of research across companies: instead of each firm reinventing the wheel, the aim is to share knowledge and build on each other’s progress. Other examples include direct subsidies or investment aid for private sector firms.

Industrial policy can be economically rational. Concerning investment in basic research, the state has longer time horizons and deeper pockets than individual companies. It can take on higher risks. Through its commitment, it can coordinate and stimulate investments from the private sector that would not be possible without prior state involvement. These are the classic arguments for industrial policy.

3. How significant is industrial policy in the German economic model as it stands?

Very significant. German economic policymakers are nearly always also industrial policymakers. After all, a politician’s personal success depends, to a significant extent, on having successful firms and sectors in their constituency to provide prosperity, jobs and tax revenues there.

It is no surprise, then, that promising firms and sectors are nurtured and supported, more or less openly. Take R&D funding: in Germany we have an extensive network of research institutes, such as the Fraunhofer Gesellschaft or the HelmholtzGesellschaft, which cooperate closely with firms on market-oriented R&D. This works well and, I should add, goes well beyond basic research.

More extensive forms of industrial policy, for example subsidies, are rarely talked about. Ordoliberal rhetoric is often used as a cover in German debates: the state’s role is to provide a “good investment climate,” the market does everything else. In my view, however, this is a distorted image: serious, long-term-oriented politicians have always concerned themselves with the major (re)location or investment decisions of large companies, whether through offering industrial sites, linking public infrastructure projects to private investment, or other forms of more or less overt public support.

Truth be told, the question is not whether the state pursues industrial policy, because it always does. The question is about how: what specific instruments are used, and towards which ends?

4. Is this West German, hidden, form of industrial policy still fit for purpose today?

For some years now, The Economist has written about a “new cold war,” a battle for technological leadership between the major global economic blocs. And indeed, the international context in which German and European industrial policy takes place has changed fundamentally. To the East, the Chinese government is consolidating its strategic industrial policy around the “Made in China 2025” plan. The aim is for Chinese manufacturing firms, for example in mechanical engineering and medical devices, i.e. in some of the key sectors of German industry today, to gain global market share and ultimately achieve market leadership.

To the West, Donald Trump instituted his “America first” policy in 2017. This is primarily a defensive strategy, directed against China, which aims to secure and, if possible, deepen the economic hegemony of the United States. Trump is using decidedly protectionist means to achieve this. But in essence his trade war is nothing more than an extreme form of industrial policy.

5. How can Europe counter this?

Whatever else it does, Europe cannot simply stand by and pretend that nothing has happened. If other countries actively strive to dominate industrial sectors fundamental to our prosperity, we must react. In the current international context, we Europeans have to pursue an industrial policy to defend our “absolute advantage”, whether we have an intellectual-semantic problem with that or not.

The logic resembles that of strategic trade policy. The European Union reacted very successfully to Donald Trump’s tariffs, by imposing its own retaliatory tariffs, and in the end defused the trade conflict, at least for the time being.

Of course, a European industrial policy would have to develop Europe’s strengths in a targeted and tangible manner. A good industrial strategy is an investment strategy.

6. German Minister for Economic Affairs and Energy Peter Altmaier recently presented his “National Industrial Strategy.” Together with his French counterpart, Bruno Le Maire, he wants to create “European Champions” to match large competitors from China and the USA: does size matter? Are these the right instruments?

Altmaier’s paper is asking the right questions, openly so, and that is to be welcomed. Unfortunately, however, there is much to criticize concerning the proposed instruments and answers. The strategy lacks an investment agenda. Instead, the creation of “European champions”, i.e. ever-larger firms, through the softening of merger rules is the paper’s prime proposal. That’s the wrong tool.

Take the following example: The Chinese rail giant CRCC is systematically winning market share in Turkey, Latin America and Africa, with the help of domestic economies of scale and unbeatable financing offers. This is one aspect of the so-called “Belt and Road” initiative, a sister program of “Made in China 2025.”

European railway manufacturers, of course, would also like to export to these markets. But neither Siemens nor Alstom can succeed, on their own, against the state-subsidized might of CRCC. Hence the idea of a merger to create a European rail champion to match CRCC. But what would have been the result? Higher market shares in export markets, perhaps, but also a quasi-monopoly in Europe and thus higher rail prices in Spain, Italy and on the whole continent. At best, granting an export cartel would have made sense, but a merger, no.

Generally speaking, weakening competition at home is a bad way to succeed in competition with the Chinese. There is simply no evidence that this strategy works. Instead, Europe must strive for technological leadership and secure its market shares in that way. We must try to maintain and expand our market position in the central industrial sectors through new, better or safer products. But neither quality nor innovation comes cheap. They require investments, most importantly by the relevant companies themselves, but also by the state. This is where the classic arguments mentioned earlier come into play.

Of course, an investment strategy—unlike the weakening of merger and competition laws and regulation—costs a lot of public money. And in the EU, with its restrictive budgetary and fiscal rules, mobilizing significant sums is not easy. Maybe that is why Altmaier’s industrial strategy is such thin gruel, because he did not dare touch certain sacred cows. But it’s here that any serious discussion must begin.

7. American and Chinese firms dominate digital winner-takes-all platforms and technologies. Is a “digital Airbus,” i.e. a European champion for digital services and data processing, an answer to this?

It is difficult for me to judge which specific sectors Europe should focus on. But two aspects seem important to me: First, it cannot be a question of entering into price and cost competition around existing business models. I simply do not see a European Google or anything like that on the horizon, and we would probably not have a chance of creating one, even if we tried. The focus should be where Europe is already leading today. Or even better: on business areas that do not even exist today.

Second—and here I do have something specific in mind—climate protection must play a central role in any European industrial strategy. When it comes to green technologies, e.g. energy storage, alternative propulsion technologies, and so on, Europe (and Germany in particular) continues to be at the forefront.

But—to repeat myself—a “green industrial policy” needs money and willpower. Scaling up existing research initiatives, or creating a number of European Institutes of Technology capable of competing with the best American institutes in terms of equipment and flexibility, is expensive. Further, since applied research requires tight links to industry, attracting research-intensive companies to the right sectors and locations is important—and rarely cheap. Mind you, a targeted research and development drive for climate-friendly technologies could be financed via bonds, since we are talking about long-term social and economic goals here.

8. What are the most important pitfalls that industrial policy faces in practice?

The biggest problem for successful industrial policy is the inherently limited nature of state knowledge, as well as the practical limits of state control. There is always a danger that public money backs the wrong horse, sinking large sums of taxpayers’ money in the process. Hayek’s classic argument, the “pretence of knowledge”, must be taken seriously. In addition, there are political economy problems, such as when industries are promoted because their stakeholders are well connected, rather than in virtue of their potential for productivity or innovation.

However, these pitfalls do not imply that we should abstain from industrial policy. What they call for is caution and smart design.

9. What can Germany learn from other countries? What are noteworthy examples?

Generally speaking, there is an abundance of anecdotes but a shortage of systematic evidence on industrial policy. Nevertheless, existing research holds certain lessons: experience from South Korea or Japan, for example, shows that the most successful forms of industrial policy promote dynamic industries on the basis of broadly defined goals and without selecting specific technologies.

An example: instead of focusing exclusively on electric vehicles, the state should set “emission-neutral mobility” as the goal and allow for the exploration of alternative technologies such as fuel cells or synthetic fuels. At some point, this may lead to problems with a lack of scaling if several technologies are developed in parallel. Eventually, there may come a point where one has to decide. But betting on a single horse right from the start is dangerous—it could be the wrong one.

10. Even if, with a technology-neutral strategy, there is a risk of more bad investments?

One of the not-so-secret secrets of Silicon Valley is its “embrace of failure.” Out of ten start-ups, seven fail, two just about survive, and only one really takes off. That’s enough, however, for venture capital funds to be profitable. Public industrial policy could work in a similar way. It simply won’t work if money is only committed on absolutely sure things.  There must be experimentation and an appetite for risk, even when it comes to taxpayers’ money.

At the same time, industrial policy must have off-ramps and exit strategies. This is perhaps the hardest problem: if an idea or a technology does not take off, the state cannot support it forever. At some point the rug must be pulled.

These decisions are not easy. There are many possibilities for error. But to abandon industrial policy and leave the field to others, because we (falsely) do not believe the state to be capable of it, is no longer an option in today’s world.

11. What could the next European Commission do if it wanted to set the right conditions for this?

Europe must recognise that industrial policy is necessary in today’s world. But it must not rely on harmful instruments simply because they are cheap.

Industrial policy is above all the targeted promotion of innovation, green technologies and new sectors and industries. And I cannot stress it enough: this is costly. But that’s OK! Innovation, green technology, and success in the industries of the future are worthwhile goals on which to spend public money. To find these funds, the new EU Commission must find clever financing models, perhaps in cooperation with the European Investment Bank and the ECB.

When doing so, the new Commission must keep Europe’s priorities in mind. After all, industrial policy is about the value creation and good jobs of tomorrow, together with emission neutrality and climate protection. These objectives are more important than restrictive fiscal rules.


Picture: © Jarko Sirkilä

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