Chinese Industrial Policy is Failing

By Alex Tabarrok.

"In Picking Winners? Government Subsidies and Firm Productivity in China, Branstetter, Li and Ren look at the effect of direct cash subsidies to Chinese firms.

Our results provide little evidence to support the view that government subsidies have been given to more productive firms or that they have enhanced the productivity of the Chinese listed firms. First, at the aggregate level, subsidies seem to be allocated to less productive firms, and the relative productivity of firms’ receiving these subsidies appears to decline further after disbursement. Second, using the categorized subsidy data, we find that neither subsidies promoting R&D and innovation promotion nor subsidies promoting industrial and equipment upgrading are positively associated with firms’ subsequent productivity growth. On the other hand, we find there is a positive association between subsidy and employment, both for aggregate and employment-related subsidies.

I appreciated this discussion of the earlier debate over Japanese industrial policy:

Drawing upon qualitative methods and largely anecdotal evidence, a group of noneconomists, business experts, and policymakers argued that Japan’s rapid recovery and robust growth after WWII could be explained by skillful industrial policy (Johnson, 1982; Prestowitz, 1988; Vogel, 1979) .10 Japan’s “government-led” economic model came to be viewed as a threat to U.S. prosperity by some participants in these debates. By the end of the 1980s, some policy makers and influential experts were calling for a policy of “containing Japan,” lest its unbalanced growth undermine the economy of the United States (Fallows, 1989).

Economists and more empirically minded social scientists in other disciplines viewed the claims of industrial policy efficacy with skepticism and suggested that Japan’s intervention in its economy tended to favor declining industries rather than growing ones (Calder, 1988; Saxonhouse, 1983).11 Eventually, the skeptics were able to bolster their claims with hard data demonstrating that the Japanese government had offered some degree of economic support to nearly all sectors, but that the preponderance of support had not gone to the sectors or firms with the fastest productivity growth. An important turning point in this debate came in the form of a careful econometric deconstruction of the notion that industrial policy drove Japan’s economic miracle published by Richard Beason and David Weinstein in the mid-1990s. This empirical analysis at the industry level found no relationship between productivity growth and the alleged instruments of industrial policy (Beason and Weinstein, 1996). As it turned out, the policy efforts to promote rising sectors championed by some elements of Japan’s bureaucracy were undermined by countervailing efforts to buttress the employment levels and solvency of politically connected but economically weak firms and industries.

Japan’s long period of economic outperformance came to an abrupt end in the early 1990s; after two decades of slow growth, few scholars now argue that Japanese industrial policy is a model worthy of emulation (Ito & Hoshi, 2020).

As I emphasized in my post, What Operation Warp Speed Did, Didn’t and Can’t Do, you need a lot more than “market failure” to have a successful government subsidy program of firms–you need massive externalities and precise, well understood targets. The garden-variety market failure that can be shown on a blackboard isn’t enough, in part because such arguments often underestimate the market and in part because they overestimate government."