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«Green industrial policy Dani Rodrik* Downloaded from at Princeton University on February 5, 2015 Abstract Green ...»

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Oxford Review of Economic Policy, Volume 30, Number 3, 2014, pp. 469–491

Green industrial policy

Dani Rodrik*

Downloaded from http://oxrep.oxfordjournals.org/ at Princeton University on February 5, 2015

Abstract

Green growth requires green technologies: production techniques that economize on

exhaustible resources and emit fewer greenhouse gases. The availability of green technologies both lowers social costs in the transition to a green growth path and helps achieve a satisfactory rate of material progress under that path. The theoretical case in favour of using industrial policy to facilitate green growth is quite strong. Economists’ traditional scepticism on industrial policy is grounded instead on pragmatic considerations having to do with the difficulty of achieving well-targeted and effective interventions in practice. While these objections deserve serious attention, I argue that they are not insurmountable. A key objective of this paper is to show how the practice of industrial policy can be improved by designing institutional frameworks that counter both informational and political risks.

Key words: green growth, industrial policy JEL classification: Q58 I. Introduction Green growth can be defined as a trajectory of economic development that is based on sustainable use of non-renewable resources and that fully internalizes environmental costs, including most critically those related to climate change. Green growth requires green technologies: production techniques that economize on exhaustible resources and emit fewer greenhouse gases. The availability of green technologies both lowers social costs in the transition to a green growth path and helps achieve a satisfactory rate of material progress under that path. A critical task facing policy-makers is to ensure investments in green technologies take place on an appropriate scale.1 This paper considers the role that industrial policy can play in achieving this objective.

As I discuss in the next section, the theoretical case in favour of using industrial policy to * School of Social Science, Institute for Advanced Study, Princeton, NJ, e-mail: drodrik@ias.edu This paper was written for the Grantham Research Institute project on ‘Green Growth and the New Industrial Revolution’. The first draft was completed at the Blavatnik School of Government, University of Oxford, during my tenure as Sanjaya Lall Visiting Professor; I thank both the Blavatnik School and the Sanjaya Lall Memorial Trust for their support. I am also grateful to Adele Faure for excellent research assistance, and to Alex Bowen, Dieter Helm, and Cameron Hepburn for comments and suggestions.

1 For various analytical perspectives on green growth, see Jaffe et  al. (2004), de Serres et  al. (2010), Bowen and Fankhauser(2011), Hallegatte et al. (2011), Acemoglu et al. (2012), Karp and Stevenson (2012), and Schmitz et al. (2013) for conceptual analyses of policies that promote green growth. On industrial policy, see Rodrik (2007, ch. 4) and Rodrik (2008), on which this paper draws.

doi:10.1093/oxrep/gru025 © The Author 2015. Published by Oxford University Press.

For permissions please e-mail: journals.permissions@oup.com 470 Dani Rodrik facilitate green growth is quite strong. Economists’ traditional scepticism on industrial policy is grounded instead on pragmatic considerations having to do with the difficulty of achieving well-targeted and effective interventions in practice. While these objections deserve serious attention, I argue that they are not insurmountable. A key objective of this paper is to show how the practice of industrial policy can be improved by designing institutional frameworks that counter both informational and political risks.

The outline of the paper is as follows. In section II, I review the theoretical case for green industrial poIicy as well as the arguments against. Next, I provide a brief overview of the range of green industrial policies already in place in the United States, Germany, China, and Japan (section III). I then discuss a specific instance of industrial support that ended

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II. The case for green industrial policy: strong in theory, ambiguous in practice If markets worked well, natural and environmental resources were priced appropriately at full social marginal costs, and technological benefits were fully internalized by those who undertook R&D, we could in principle leave such investment decisions in the hands of entrepreneurs, corporations, and financial markets. But there are three sets of considerations that drive a wedge between private and social returns to investment in green technologies.

First, the development of new technologies generates positive spillovers that are not fully captured by the original investors. These may take the form of cross-firm externalities, industry-wide learning, skill development, or agglomeration effects. Such ‘market failures’ exist in general for all kinds of new technologies, whether they are of the green or dirty kind. However, their novelty, their highly experimental nature, and the substantial risks involved for pioneer entrepreneurs suggest green technologies may be particularly prone to these failures.

An additional reason why green technologies may need to be publicly subsidized is that carbon (which I use as shorthand for greenhouse gases (GHGs) generally) is greatly mispriced. This is a second-best reason for government intervention in support of green technologies. The presence of subsidies on fossil fuels and the failure to implement taxes or controls that would internalize the risks of climate change result in the user cost of carbon falling substantially below the level that is appropriate from a long-term societal perspective.2 This means that the private return to green technologies lies significantly below the social return, even when we ignore the traditional R&D spillovers.3 Put 2 The IMF (2013, pp. 13–14) estimates that effective subsidies on energy amount to $1.9 trillion (or 2.5 per cent of world GDP). The bulk of this subsidy arises from the absence of taxes needed to internalize the negative climate and health externalities generated by burning fossil fuels.





3 On the empirical relation between fuel prices and carbon-saving innovation in the auto industry, see Aghion et al. (2012). This second-best role for policies supporting green technologies is also emphasized by Jaffe et al. (2004). Bosetti et al. (2010) consider quantitatively the role of innovation policies to substitute for explicit carbon control policies and conclude that they are not sufficient, even under optimistic assumptions, to stabilize GHG concentrations and temperatures.

Green industrial policy 471 differently, the case for subsidizing green technologies is broader and stronger than the general case for alleviating R&D-related market failures: the under-pricing of carbon generates an independent motive for industrial policy in this area.

R&D externalities and carbon under-pricing provide mutually reinforcing reasons for why the world would be collectively better off if governments nurtured and supported green technologies. However, what is true for the world as a whole need not be true for national governments interested in maximizing domestic welfare. The benefits of carbon abatement represent the archetypal global public good, generating strong incentives for individual countries to free ride on others’ efforts. In a world where governments do not internalize the global benefits of carbon taxes/controls in the first Downloaded from http://oxrep.oxfordjournals.org/ at Princeton University on February 5, 2015 place, it is unlikely that they will place much value on green technologies on account of these technologies’ impact on the global stock of GHGs. Similarly, R&D externalities from the development of new green technologies are in many instances global rather than national. Learning sometimes spills over quickly across national borders to firms located in other countries. To the extent that governments anticipate (or fear) such spillovers, their incentive to invest in green technologies is further diluted.

Yet, as I document in the next section, government support for green industries is rampant, both in advanced and emerging economies. Often, the motive seems to be to give the domestic industry a leg up in global competition. Under certain conditions, this may be a sensible strategy from a national standpoint—although the global implications (absent the two considerations above) are often ambiguous or negative. For example, a first-mover advantage in certain technologies can tilt the future path of technological development in a direction that is closer to a country’s initial comparative advantage, providing long-term terms-of-trade benefits to the home economy. Or, subsidizing investment in home technologies can shift rents from foreign producers in imperfectly competitive industries. Such competitive motives are the third set of considerations that drive a wedge between private and social optimality in markets for green technologies.

Normally, we consider these competitive motives to be of the beggar-thy-neighbour type. Terms-of-trade or rent-shifting effects are zero-sum from a global standpoint, and any resources invested in generating those national gains come at the cost of global losses. However, in the highly second-best context of green growth, national efforts to boost domestic green industries can serve to offset the two sets of market failures discussed above, even if the motives are narrowly national and carry beggar-thy-neighbour connotations. When cross-border spillovers militate against taxing carbon and subsidizing technological development in clean industries, boosting green industries for competitive reasons is largely a good thing, not a bad thing. However, by the same token, when these national strategies take the form not of subsidizing domestic industries but of taxing or restricting market access to foreign green industries, they have to be considered triply damaging. Luckily, as the overview in the next section shows, trade restrictions have so far played a small role relative to subsidies to domestic industry.4 Economists traditionally exhibit scepticism—if not outright hostility—towards industrial policies. But these considerations suggest that they should look kindly at 4 An important exception that does not take away the main point is the raising of tariffs on imports of

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industrial policies geared towards green technologies. Industrial policies have an indispensable role in putting the global economy on a green growth path. The imperative of addressing climate change places industrial policy squarely on the policy agenda of governments.

The trouble is that industrial policy has a very chequered history. While it has undoubtedly worked in many places in East Asia to foster structural change and new industries (Japan, South Korea, Taiwan, China), in advanced countries and many developing countries it remains synonymous with white elephants, rent-seeking, and good money spent after bad. In truth, such caricatures are wildly at variance with the actual contribution industrial policy has made to technological development in the United Downloaded from http://oxrep.oxfordjournals.org/ at Princeton University on February 5, 2015 States and Europe. Any critic of industrial policy can identify a string of expensive failures: the Concorde, national champions in autos and aviation, and so on. Yet it is also the case that government support has played a crucial role in the development of key industries in the US such as Silicon Valley or biotechnology—a fact that is acknowledged by industrial policy’s critics (e.g. Lerner, 2012) as well as its supporters (e.g. Block and Keller, 2011). Mazzucato (2013) has recently argued that every key technology in the iPhone—the touchscreen display, the GPS, voice-activated assistant—has benefited from public funds.

Neither does infant-industry promotion in developing nations quite deserve its negative reputation in academic circles. Scores of developing countries registered productivity growth rates under import-substitution policies that far exceed those they have experienced in recent decades (Rodrik, 1999). And virtually every major non-traditional export product in Latin America, from salmon in Chile to aircraft in Brazil, owes its existence to industrial policy of some sort. Nevertheless, making industrial policy work is a challenge, and one that needs to be confronted head on if green industries are to play their proper role in green growth.

The case against industrial policy comes in two forms. The first counter-argument is that governments do not have the information needed to make the right choices as to which firms or industries to support. Usually presented with the formulaic statement ‘government cannot pick winners’, this suggests governments are likely to make lots of mistakes and hence waste considerable resources, even when they are well intentioned. The second counter-argument is that once governments are in the business of supporting this or that industry, they invite rent-seeking and political manipulation by well-connected firms and lobbyists. Industrial policy becomes driven by political rather than economic motives. In the United States, the case of Solyndra—a solar cell manufacturer that folded after having received more than half a billion dollars in loan guarantees from the US government—provides a recent illustration where both failures were apparently in play. I review and discuss the Solyndra case later in the paper.



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