Industrial Policy, Mercantilism, and "Dynamic Comparative Advantage"

A recent post by law and policy experts Robert Atkinson and Michael Lind claims that "ECON 101 is Killing America." They make ten specific points, of which some carry a certain amount of validity and some of which do not. The more valid points can be boiled down in to one broad point, which Noah Smith paraphrases quite well, and is Matthew Yglesias echoes. According to Smith and Yglesias, Atkinson and Lind argue that Mercantilism got something right that classical economists like Smith and Ricardo missed, specifically that by focusing on static notions of efficiency, the classical economic students learn at the undergraduate level ignores the benefits of industrial policy and mercantilism on long run growth.

This is essentially true. Economics, both as a profession and in my own classes may focus too much on the distortions created by monopolies, government intervention, and public choice concerns of corruption, special interest groups, and so-called government failure and too little on the benefits of government intervention. At the same time I am perhaps quicker than some of my peers to point out the prevalence of market failures, as well as the Herculean assumptions one must accept in order for the basic propositions about welfare and efficiency can be expected to hold.

Yet, the idea that (government) industrial policies might help the economy in the long run is nothing new. In the extreme, formerly Socialist economies in the Soviet Union and Eastern Europe experimented with industrial policy in the form of complete government control over the economy with spectacularly disastrous results. To a lesser extent, Brazil experimented with a form of industrial policy known as "Import-Substitution Industrialization" based largely on the Prebisch Thesis (Frankenhoff, 1962). Brazil's experiment collapsed under the weight of mounting government deficits that were needed to sustain the industrial sectors in which the government was attempting to build comparative advantage (Baer, 2008). Based on these historical experiences, I remain largely a believer in the virtues of free trade under most circumstances.

That being said, there is still a strong argument for the fact that focusing on comparative advantage and the static gains from trade for providing the sole basis of evaluating industrial policy is misguided. There is something to the notion of "dynamic comparative advantage" as well as to the notion that using de facto tax revenues from government-controlled natural resource enterprises to develop new comparative advantages in industrial sectors that complement resource extraction. To (badly) paraphrase the Shumpeterian notion of creative destruction, an economy which is always statically efficient may actually do worse in the long run because it is not growing by innovating.

Most of the class will focus on the basic welfare propositions we have encountered over the last few (and next few) classes. Throughout the course, however, I do look forward to having a dialog on what those propositions may be sweeping under the rug.