Industry policy is back
Long live industry policy
There are few economic policies that generate more knee-jerk opposition from economists than industrial policy.
So goes the opening line of Juhász et al. in their landmark paper ‘The New Economics of Industrial Policy’.
The old adage that “governments can’t pick winners” is drummed into every freshly minted economist.
Yet, as Llewelyn Hughes from the ANU so eloquently described our current economic landscape: “industrial policy is back – with a green twist”.
Australia’s response to the US' Inflation Reduction Act (IRA), our own homegrown Future Made in Australia (FMIA) Act has been met with mixed reviews.
The Commonwealth says it provides a landmark investment for crowding-in private capital to develop critical industries. The purists see it as just the latest incarnation of policy bets placed with imperfect information.
What’s different this time is that the Commonwealth Treasury has been hard at work, developing a National Interest Framework (NIF) to inform investments under the Act.
So what qualifies as being in the Australian national interest?
Treasury’s NIF describes two worthwhile ideas:
Net Zero Transformation Stream - industries that will make a significant contribution to the net zero transition
Economic Resilience and Security Stream - industries where domestic capability is necessary to deliver economic resilience and security
This more or less aligns well with the academic literature. Juhász et al. group the compelling and well founded rationales for industry policy into two broad buckets:
👉 Positive externalities through learning and R&D are widely recognized when innovation in one sector up-skills labor and creates spillovers to the wider economy. There are also positive national security externalities when an economy reduces dependence on foreign supply (albeit at a reasonable cost).
👉 Coordination failures occur when one industry can’t flourish because of mismatched supply/demand downstream or upstream. Without intervention, no firm is willing to invest.
The classic case in Australia of a coordination problem is H2 production for steel. Steel production can be decarbonised using zero-emission H2 for both the heat and the chemical reaction in the iron-making process - but the H2 has to come from somewhere.
Recent industry policy to encourage hydrogen production (including direct rebates for each kg of hydrogen produced) aims to foster ‘downstream’ heavy industrial development.
Juhász et al. rightly suggest ‘the ultimate test is not whether governments can pick “winners,” but whether they have (or can develop) the ability to let “losers” go’.
The Productivity Commission is singing the same tune. In their Senate Economics Committee submission to the FMIA, they advised that ‘off-ramps should be built into policy design, and triggered in the event that FMIA supports are not achieving their policy goals’.
It seems that picking winners may well be part luck, part skill.
