Developing the toolbox for a contemporary and sustainable industrial policy
By Guido Nelissen[1], April 2011
The objective of this paper is to develop a tool-kit for a sustainable industrial policy. The paper starts by setting the scene with a description of the structural challenges industry is confronted with. Then it tries to shed some light on the often controversial and obscure nature of industrial policy. Indeed, the term ‘industrial policy’ refers to various concepts ranging from providing an environment conducive to private business to targeted state intervention on companies and sectors. Therefore it is important to provide insight into the changing concepts and rationale for industrial policy. This is followed by an overview of the different policies that constitute the toolbox for a contemporary industrial policy and by a description about how the creation of open markets within Europe has led to sea-changes in the thinking on industrial policy. Finally, the paper tries to look into the toolbox for a sustainable industrial policy that is capable of tackling the challenges of the ‘third industrial revolution’.
1. Industry at the crossroads of structural change
A strong manufacturing base is essential for sustained economic growth and stability in Europe. And a strong growth- and innovation-focused industrial policy is essential to European companies, workers and consumers in the context of economic instability and the challenges of sustainable development. Despite intense processes of de-industrialisation, EU’s industry still plays a major role in Europe’s economy because:
- Industry still represents ¼ of European GNP and employment (construction and energy included)
- Its productivity grew by 47% over the period 1995-2007 against an overall productivity growth of less than 20%
- ¾ of European exports are made up of industrial goods. Exports of goods have increased by 4,7% p.a. over the period 2000-2008, substantially faster than industrial production
- Industry is a driver for the development of all kinds of services: each job in industry creates at least one extra job in the sector of business- related services (business-related services provide already 37% of all private employment)
- Industry represents 80% of all private R&D
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Toolbox for a Sustainable Industrial Policy
- Industry contributes to the solution of many societal problems (environment, mobility, healthcare, better quality of life, bringing sustainable development objectives closer).
But industry is currently under pressure from a broad range of mutually reinforcing challenges:
1. A 20% decline in industrial production (and a 10% decline in employment) as a result of the financial crisis, which meant the failure of the paradigm of self-regulation of financial markets. It should be clear that the financial sector has to serve the real economy and not vice -versa. Therefore, re-regulation and proper supervision are urgently needed to ensure that financial markets promote rather than endanger the growth of the real economy. The financial crisis added also to worries about the growth potential of the (Western-) European economies as economic growth apparently can only be sustained by the creation of bubbles (burst of the dotcom-bubble in 2001 and of the subprime-bubble in 2008).
2. The new international division of labour with fast-growing and emerging economies (BRIC) adds a new dimension to the ongoing process of globalization.
3. The increasing speed of technological development and technology diffusion with an increasing presence of emerging economies in ‘high-tech’ sectors (supported by rapid advances in information and communication technologies). As a result, specialization in high value-added products and production provides less and less of a shield against competition.
4. The evolution towards a (global) knowledge society. As a consequence, innovation and research have taken over from physical capital and manual work as the driving force for growth and competitiveness.
5. Climate change and the challenge of sustainable development urge industry to move towards carbon-free and resource-efficient production.
6. The ageing of our populations raises specific challenges: new products and services to support elderly people, the challenge of active and healthy ageing, the increase in the average age of retirement, the employability of older workers, skills shortages, etc.
7. Emergence of a whole range of enabling technologies such as biotechnology, nano-technologies and new materials that may bring about major changes in the organization of production and new activities and create the basis for new industries as well as transform existing ones
8. Rapidly falling communication and coordination costs have removed the need to perform manufacturing stages near to each other, thus facilitating the geographical dispersion of different production activities related to the same product. This is reflected in the offshoring/relocation of labour-intensive (and low-skilled) production stages and driven by the advances in digital technologies and virtual zero telecommunication costs. Global competition is no longer over products but over spatially unpacked production processes.
9. Closely related to the previous point is the emergence of tightly interlinked - and geographically ever more dispersed - value chains. Previously integrated industrial operations have been sliced up into highly complex, smaller manufacturing and service packages which are globally redistributed. As a result, industrial sectors can no longer be treated as homogeneous, independent and national. Value chains are increasingly complex and intertwined, vertically segmented, and cut across traditional sector-based categories and geographical boundaries. This has a number of consequences:
ü increasing importance of networks of suppliers and innovation partners and for companies to move to strategic positions inside these supply chains;
ü the performance of companies is increasingly dependent on the performance of upstream activities (not only for production operations but also for previously internal service functions);
ü The growing importance of targeted policies directed towards specific elements within value chains of specific categories of firms or towards strengthening linkages and creating synergies within value chains. National industrial policy will be more and more oriented towards the support and development of these value chains, and strengthening of the position of home-companies inside these globalised company networks, rather than on general sectoral policies.
ü The emergence of global value chains is facilitating the rapid integration of developing countries and former Communist countries into the global economy by the transfer of capital, technology and knowledge.
10. The blurring borders between industry and services, the so-called ‘tertiarization’ of industry (a term which is preferable to ‘de-industrialisation’ which is not really reflecting what is going on), is rendering traditional statistical classifications obsolete as tools for policy-making (since these make a clear difference between industry and services). A substantial component of the rising share of services in economic activity is attributable to the ‘outsourcing’ to specialized service providers of services activities previously undertaken within industry. Firms even switch from being manufacturers to re-inventing themselves as service providers. This may take the form of a total reorientation of business or be part of an unbundling of production processes (associated with processes of fragmentation, off-shoring, vertical specialization or splitting-up of the value chain) through which firms disinvest themselves of actual manufacturing production processes. Finally, many industries derive a significant part of their added value from the delivery of services that accompany the goods that they provide. Consequently, instead of addressing the issue of de-industrialisation, industrial policy has to adequately capture the close inter-linkages between industry and services.
11. The ongoing challenge of integrating the industries of Central- and Eastern-Europe into the Western European economic fabric.
12. The creation of a monetary union in Europe with a gradual build-up of internal tensions because of the absence of an economic union. Currently, the sovereign debt crises in Greece, Ireland and Portugal have led to an intense debate about the future of the euro and the economic governance of the euro-zone. The new economic architecture of the EU (strengthened Stability and Growth Pact, Economic imbalances procedure, Annual Growth Survey and the Euro plus pact) will have a huge impact on the industrial development of the Mediterranean member states (and Ireland).
The need to address the long list of structural challenges that industry is confronted with lies at the base of the re-discovery of industrial policy, mainly since the turn of the century when the burst dotcom-bubble acted as a kind of wake-up call to politicians.
2. Industrial policy: a ‘moving’ concept
“There is a great deal of confusion about what industrial policy is, only surpassed by the confusion about what European industrial policy might be’ [2]
Although industrial policy has for many decades been a controversial concept, a clear rationale for industrial policy in economic theory does exist. There is a large consensus over the fact that state interventions have to correct for market failures, market barriers and externalities which hinder the emergence of well-functioning markets and the efficient allocation of scarce resources. Monopolies are a clear example of market failure. But market failures also refer to the fact that individual firms do not have the capacity to invest in the public infrastructure (roads, schools, R&D) that they need in order to function properly.
Market barriers exist because of information gaps (e.g. about the market potential for launching new products, and about cost structures of new activities) and coordination problems (setting-up a new activity requires the creation of a new supply chain, which is beyond the capacity of an individual firm; standards have to be established in order to define products/markets).
To lift market barriers or to correct for market failures, it is clear that industrial policies are needed to regulate markets, to provide public infrastructure, to correct for information asymmetries and to support R&D or projects with a long payback period.
Finally, externalities are costs and benefits which are not transmitted through prices. Pollution is the best known example of an external cost, while exploiting an invention discovered by somebody else can be considered to be a positive externality. Governments have to correct for these externalities by regulations and ‘internalize’ these costs and benefits e.g. by taxes and subsidies, by the introduction of intellectual property rights or by requiring the polluter to repair damages.
Although economic theory does not provide a generally accepted definition of industrial policy, we could say that industrial policy refers to all micro-economic instruments with a structural impact on companies (= influencing the strategic decision-making process) and on the regulatory framework in which they operate.
This definition does not mean that industrial policy is a static concept. On the contrary, industrial policy has evolved over the years from a very broad to a very narrow interpretation. Although industrial policy lies at the origin of the European Union (European integration started in 1952 with the creation of the European Community of Steel and Coal), its importance waned during the eighties and nineties. During this period European decision-making was mainly directed to:
· Restoring the macro-economic equilibriums in the EU (inflation, public deficits, monetary stability)
· The creation of a monetary union
· The creation of a single market with free movement of capital, services and persons. Competition policy was key in the construction of the common market and industrial policy was considered as incompatible with active national industrial policies (oriented towards providing state aid to companies and to supporting the national industrial basis e.g. by the creation of ‘national champions’). National industrial policy was considered to be in complete contradiction with the creation of open markets requiring the dismantling of national barriers, subsidies and direct interventions.
· The belief that services and the ‘new’, ICT-based economy would take over wealth creation from industry, which would disappear anyway in the long run –because of de-industrialisation. Industry and industrial policy were written off as being issues of the past. The contribution of industry to society was no longer valued at its true worth.
Furthermore, there was the rise of neo-liberal radicalism, aimed at eradicating all kinds of state interventionism and stating that the best form of industrial policy was no industrial policies as free markets and free competition are the best tools to modernize industry and to remain competitive.
On top of all this there were the bad experiences with the interventionist industrial policy of the post-war era: keeping afloat ‘sunset’ (or ‘chimney’) industries, which had to restructure and slim down anyway, was detrimental to public finances and did not contribute to their survival in the long run.
To some extent industrial policy became a dirty word and a concept of the past, connected with industrial lobbying, state ownership and pouring money down the drain. Talking about industrial policy also became old-fashioned because it was seen to be in contradiction with the dynamics of free markets. As a result traditional interventionist industrial policies were gradually phased out.
All this resulted in a clear tendency to limiting the role of national industrial policy while an equivalent at
European level did not yet exist. The tool-kit for industrial policy shrunk drastically. Subsidies to keep ailing companies and sectors artificially afloat, support to ‘national champions’, protection of home markets, strategies of import substitution and, public equity in strategic companies were no longer reconcilable with the rules of the internal market. National interventionist industrial policies (the last wave of nationalizations in Europe occurred in 1982 under the presidency of François Mitterand in France) had to give way to just creating favourable framework conditions for companies to thrive. Industrial policy turned out to be policies for supporting entrepreneurs.
But faced with the bursting of the internet bubble in 2001 (which meant the collapse of the so-called ‘new’ economy) and the resulting continuous economic slowdown, many voices have been raised, calling for a contemporary and more appropriate industrial policy dealing with the important structural challenges that industry had to face in the light of globalization and the challenge of sustainable development.
Starting in 2002, the European Commission has issued six communications on industrial policy. They led to a gradual rediscovery of industrial policy in Europe and clearly showed the renewed commitment of the Commission – after two decades of silence - to protecting and strengthening the industrial base of Europe and to tackling the deep structural changes that industry is confronted with. It resulted in a clear recognition of the role of industry as a motor for social, ecological and economic progress. The wave of communications on industrial policy must also be seen as new attempts to reconcile industrial policy with the requirements of the internal market and the challenges of worldwide competition.