Class 1 - Political Economy and Informational Dimensions of Industrial Policy.
Class 1 overview: Hilary Term Week 6. One hour lecture, MSc. Dev. room.
In the previous class we introduced the impetus of industrial policies. Specifically, the idea of a second-best world and my ad hoc taxonomy of market failures.
The focus of this short class was to think about the other side of the market failure justification of industrial policy: government failures. Accordingly, we consider a related concept as it relates to industrial policy, rent seeking.
“Structural development” as the background for Krueger’s “Government Failure.”
We consider why and how enthusiasm of industrial policy is tempered by political economy considerations.
I introduce a bit of history here, by considering the era of structural economics–also referred to as the era of “high developmentalism.” Where industrial policy interventions were almost synonymous with development economics.
I introduced the parable of post-independence Ghana under the leadership of the Kwame Nkrumah. Who enlisted the help of none other than Sir Arthur Lewis to construct the Second Development Plan of the newly independent nation.
I use Lewis’ fallout with the regime as an entry point for thinking about the ways in which technocratic considerations around market failures can be subverted by the realities of domestic political economy.
That is, there is an essential tensions with industrial policy (recall the definition of industrial policy): 1) allocating policy with respect to market failures and 2) the gravitational pull of politics.
I briefly illustrate this tension by consider a well-studied area in development economics, the realm of agricultural market failures and the allocation of credit and banking to the rural periphery. I consider Cole (2005) and how state-directed rural credit in India varied by the “political business cycle”, compared to that of the private banking sector.
Optimal Policy and Endogenising Political Economy
I consider political economy of optimal policy by consider a typical theoretical problem seem in public economics. Specifically, the analysis of optimal policy as chosen by a welfare maximising planner. I illustrated the selection of policy illustrating the policy decision of a planner in an optimal infant industry policy with learning-by-doing dynamics (Melitz 2004).
I juxtaposed a technocratic policy selection, to cases where we add political economy to the selection of policy.
To illustrate how political economy forces may affect the selection of optimum policy, I consider the theoretical literature on the political economy of trade policy. Specifically, I discuss (at a very high level), the classic Grossman-Helpman (1999) model of “Protection for Sale.”
By merely considering the structure of the “game” (between politicians and lobbies) introduced by the now-classic Grossman-Helpman model, one sees how political constituencies and political incentives complicate the selection of welfare maximising policy.
The discussion of this these concepts highlight the distinction between political feasibility versus economic feasibility. I feel this distinction was taken quite seriously in the theoretical considerations of political economy of trade policy, and this distinction is useful in considering the economic justifications of industrial policies versus the political realities underlying these policies. Political economy forces are what makes these policies the object of “protectionist entrepreneurs,” in the words of Robert Baldwin (1989).
Information and Political Economy
We then consider a related question on the political feasibility of industrial policy: do governments have adequate information to target policy?
I consider the demand for information in terms of industrial policies. After all, “out market failure” justification of industrial policy rests on the politicians and the state having the informational capacity to identify market failures in the first place.
I relate this argument to the historic debate between communist economists and Hayek (AER 1945). I consider the points made by Hayek, and how we should consider the in light of the debates of industrial policy action.
I consider the ability of governments to deploy policy in light of the recent trade wars. I ask the question: what does retaliatory policy tell us about the abilities of states and their use of information?
While we did not have time to cover it (and it will not be tested), consider the political economy of industrial policy in terms of Peter Evan’s idea of embedded autonomy. I argue that this literature in political sociology tries to discipline the world of government and information failures in the light of industrial policy. Evan’s work on “Embedded Autonomy” attempt to explain cross-country variation in the political success of industrial policy. By considering state institutions that constrain rent-seeking and promote informational flows to bureaucrats.
Bibliography.
Baldwin, R. E. (1989). The Political Economy of Trade Policy. Journal of Economic Perspectives, 3(4), 119–135. https://doi.org/10.1257/jep.3.4.119
Cole, S. (2009). Fixing Market Failures or Fixing Elections? Agricultural Credit in India. American Economic Journal: Applied Economics, 1(1), 219–250. https://doi.org/10.1257/app.1.1.219
Evans, P. B. (1992). The State as Problem and Solution: Predation, Embedded Autonomy, and Structural Change. In S. Haggard & Robert R. Kaufman (Eds.), The Politics of Economic Adjustment: International Constraints, Distributive Conflicts and the State (pp. 139–181). Princeton University Press.
Evans, P. B. (1995). Embedded Autonomy: States and Industrial Transformation. Princeton University Press. Fetzer, T., & Schwarz, C. (2020). Tariffs and Politics: Evidence from Trump’s Trade Wars. The Economic Journal. Grossman,
G. M., & Helpman, E. (1994). Protection for Sale. The American Economic Review, 84(4), 833–850.
Hayek, F. A. (1945). The Use of Knowledge in Society. The American Economic Review, 35(4), 519–530. http://www.jstor.org/stable/1809376
Kanbur, R. (2017). W. Arthur Lewis and the Roots of Ghanaian Economic Policy. In The Economy of Ghana Sixty Years after Independence. Oxford University Press. https://doi.org/10.1093/acprof:oso/9780198753438.003.0002
Krueger, A. O. (1974). The Political Economy of the Rent-Seeking Society. The American Economic Review, 64(3), 291–303. http://www.jstor.org/stable/1808883
Krueger, A. O. (1990). Government Failures in Development. The Journal of Economic Perspectives, 4(3), 9–23.
Jedwab, R., & Osei, R. D. (2012). Structural change in Ghana 1960-2010. Institute for International Economic Policy Working Paper.
Staiger, R. W., & Tabellini, G. (1987). Discretionary Trade Policy and Excessive Protection. The American Economic Review, 77(5), 823–837. http://www.jstor.org/stable/1810211