I was on a virtual panel last week on industrial policy as derisking, in response to an important new paper by Daniela Gabor. For me, the conversation helped clarify why people who have broadly similar politics and analysis can have very different feelings about the Inflation Reduction Act and similar measures elsewhere.
There are substantive disagreements, to be sure. But I think the more fundamental issue is that while we, inevitably, discuss the relationship between the state, the organization of production and private businesses in terms of alternative ideal types, the actual policy alternatives are often somewhere in the fuzzy middle ground. When we deal with a case that resembles one of our ideal types in some ways, but another in other ways, our evaluation of it isn’t going to depend so much on our assessment of each of these features, but on which of them we consider most salient.
I think this is part of what’s going on with current discussions of price controls. There has been a lot of heated debate following Zach Carter’s New Yorker profile of Isabella Weber on whether the energy price regulation adopted by Germany can be described as a form of price controls. Much of this criticism is clearly in bad faith. But the broad space between orthodox inflation-control policy, on the one hand, and comprehensive World War II style price ceilings, on the other, means that there is room for legitimate disagreement about how we describe policies somewhere in the middle. If you think that the defining feature of price regulation is that government is deciding how much people should pay for particular commodities, you will probably include the German policy. If you’re focused on other dimensions of it, you might not.
I am not going to say more about this topic now, though I hope to return to it in the future. But I think there is something parallel going on in the derisking debate.
People who talk about industrial policy mean some deliberate government action to shift the sectoral composition of output — to pick winners and losers, whether at the industry or firm level. But of course, there are lots of ways to do this. (Indeed, as people sometimes point out, governments are always doing this in some way — what distinguishes “industrial policy” is that it is visible effort to pick different winners.) Given the range of ways governments can conduct industrial policy, and their different implications for larger political-economy questions, it makes sense to try to distinguish different models. Daniela Gabor’s paper was a very helpful contribution to this.
The problem, again, is that models are ideal types — they identify discrete poles in a continuous landscape. We need abstractions like this — there’s no other way to talk about all the possible variation on the multiple dimensions on which we can describe real-world situations. If the classification is a good one, it will pick out ways in which variation on one dimension is linked to variation on another. But in the real world things never match up exactly; which pole a particular point is closer to will depend on which dimension we are looking at.
In our current discussions of industrial policy, four dimensions seem most important — four questions we might ask about how a government is seeking to direct investment to new areas. Here I’ll sketch them out quickly; I’ll explore them in a bit more detail below.
First is ownership — what kind of property rights are exercised over production? This is not a simple binary. We can draw a slope from for-profit private enterprises, to non-profits, to publicly-owned enterprises, to direct public provision.
Second is the form of control the government exercises over investment (assuming it is not being carried out directly by the public sector). Here the alternatives are hard rules or incentives, the latter of which can be positive (carrots) or negative (sticks).
The third question is whether the target of the intervention is investment in the sense of creation of new means of production, or investment in the sense of financing.
The last question is how detailed or fine-grained the intervention is — how narrowly specified are the activities that we are trying to shift investment into and out of?
“Derisking” in its original sense had specific meaning, found in the upper right of the table. The idea was that in lower-income countries, the binding constraint on investment was financing. Because of limited fiscal capacity (and state capacity more generally), the public sector should not try to fill this gap directly, but rather to make projects more attractive to private finance. Offering guarantees to foreign investors would make efficient use of scarce public resources, while trusting profit motive to guide capital to socially useful projects.
In terms of my four dimensions, this combines private ownership and positive incentives with broad financial target.
The opposite case is what Daniela calls the big green state. There we have public ownership and control of production, with the state making specific decisions about production on social rather than monetary criteria.
For the four of us on the panel, and for most people on the left, the second of these is clearly preferable to the first. In general, movement from the upper right toward the lower left is going to look like progress.
But there are lots of cases that are off the diagonal. In general, variation on each of these dimensions is independent of variation on the others. We can imagine real world cases that fall almost anywhere within the grid.
Say we want more wind and solar power and less dirty power.
We could have government build and operate new power plants and transmission lines, while buying out and shutting down old ones.
We could have a public fund or bank that would lend to green producers, along with rules that would penalize banks for holding assets linked to dirty ones.
We could have regulations that would require private producers to reduce carbon emissions, either setting broad portfolio standards or mandating the adoption of specific technologies.
Or we could have tax credits or similar incentives to encourage voluntary reductions, which again could be framed in a broad, rules-based way or incorporate specific decisions about technologies, geography, timelines, etc.
As we evaluate concrete initiatives, the hard question may not be where we place them in this grid nor on where we would like to be, but how much weight we give to each dimension.
The neoliberal consensus was in favor of private ownership and broad, rules-based incentives, for climate policy as in other areas. A carbon price is the canonical example. For those of us on the panel, again, the consensus is that the lower left corner is first best. But at the risk of flattening out complex views, I think the difference between let’s say Daniela on one side and Skanda Amarnath (or me) on the other is the which dimensions we prioritize. Broadly speaking, she cares more about movement in horizontal axis, as I’ve drawn the table, with a particular emphasis on staying off of the right side. While we care more about vertical axis, with a particular preference for the bottom row.
Some people might say it doesn’t matter how you manage investment, as long as you get the clean power. But here I am completely on (what I understand to be) Daniela’s side. We can’t look at policy in isolation, but have to see it as part of a broader political economy, as part of the relationship between private capital and the state. How we achieve our goals here matters for more than the immediate outcome, it shifts the terrain on which next battle will be fought.
But even if we agree that the test for industrial policy is whether it moves us toward a broader socialization of production, it’s not always easy to evaluate particular instances.
Let’s compare two hypothetical cases. In one, government imposes strict standards for carbon emissions, so many tons per megawatt. How producers get there is up to them, but if they don’t, there will be stiff fines for the companies and criminal penalties for their executives. In the second case, we have a set of generous tax credits. Participation is voluntary, but if the companies want the credits they have to adopt particular technologies on a specified schedule, source inputs in a specified way, etc.
Which case is moving us more in the direction of the big green state? The second one shifts more expertise and decision making into the public sector, it expands the domain of the political not just to carbon emissions in general but to the organization of production. But unlike the first, it does not challenge the assumption that private profitability is the first requirement of any change in the organization of production. It respects capital-owners’ veto, while the first does not.
(Neoliberals, it goes without saying, would hate both — the first damages the business climate and discourages investment, while the second distorts market more.)
Or what about if we have a strict rule limiting the share of “dirty” assets in the portfolios of financial institutions? This is the path Europe seems to have been on, pre IRA. In our discussion, Daniela suggested that this might have been better, since it had more of an element of discipline — it involved sticks rather than just subsidy carrots. To Skanda or me, it looks weak compared with the US approach, both because it focuses on financing rather than real investment, and because it is based on a broad classification of assets rather than trying to identify key areas to push investment towards. (It was this debate that crystallized the idea in this post for me.)
Or again, suppose we have a sovereign wealth fund that takes equity stakes in green energy producers, as Labour seems to be proposing in the UK. How close is this to direct public provision of power?
In the table, under public ownership, I’ve distinguished public provision from public enterprise. The distinction I have in mind is between a service that is provided by government, by public employees, paid for out of the general budget, on the one hand; and entities that are owned by the government but are set up formally as independent enterprises, more or less self-financing, with their own governance, on the other. Nationalizing an industry, in the sense of taking ownership of the existing businesses, is not the same as providing something as a public service. To some people, the question of who owns a project is decisive. To others, a business where the government is the majority stakeholder, but which operates for profit, is not necessarily more public in a substantive sense than a business that isprivately owned but tightly regulated.
Moving to the right, government can change the decisions of private businesses by drawing sharp lines with regulation — “you must”; “you must not” — or in a smoother way with taxes and subsidies. A preference for the latter is an important part of the neoliberal program, effectively shifting the trading -off of different social goals to the private sector; there’s a good discussion of this in Beth Popp Berman’s Thinking Like an Economist. On the other side, hard rules are easier to enforce and better for democratic accountability — everybody knows what the minimum wage is. Of course there is a gray area in between: a regulation with weak penalties can function like a tax, while a sufficiently punitive tax is effectively a regulation.
Finally, incentives can be positive or negative, subsidies or taxes. This is another point where Daniela perhaps puts more stress than I might. Carrots and sticks, after all, are ways of getting the mule to move; either way, it’s the farmer deciding which way it goes. That said, the distinction certainly matters if fiscal capacity is limited; and of course it matters to business, who will always want the carrot.
On the vertical axis, the big distinction is whether what is being targeted is investment in the sense of the creation of new means of production, or investment in the sense of financing. Let’s step back a bit and think about why this matters.
There’s a model of business decision-making that you learn in school, which is perhaps implicitly held by people with more radical politics. Investment normally has to be financed; it involves the creation of real asset and a liability, which is held somewhere in financial system. You build a $10 million wind turbine, you issue a $10 million bond. Which real investment is worth doing, then, will depend on the terms on which business can issue liabilities. The higher the interest rate on the bond, the higher must be the income from the project it finances, to make it worth issuing.
Business, in this story, will invest in anything whose expected return exceeds their cost of capital; that cost of capital in turn is set in financial markets. From this point of view, a subsidy or incentive to holders of financial assets is equivalent to one to the underlying activity. Telling the power producer “I’ll give you 10 percent of the cost of the turbine you built” and telling the bank “I’ll give you 10 percent of the value of the bond you bought” are substantively the same thing.
As I said, this is the orthodox view. But it also implicitly underlies an analysis that talks about private capital without distinguishing between “capital” as a quantity of money in financial form, and “capital” as the concrete means of production of some private enterprise. If you don’t think that the question “what factory should I build” is essentially the same as the question “which factory’s debt should I hold?”, then it doesn’t make sense to use the same word for both.
Alternatively, we might argue that the relevant hurdle rate for private investment is well above borrowing costs and not very sensitive to them. Investment projects must pass several independent criteria and financing is often not the binding constraint. The required return is not set in financial markets; it is well above the prevailing interest rate and largely insensitive to it. If you look at survey evidence of corporate investment decisions, financing conditions seem to have very little to do with it. If this is true, a subsidy to an activity is very different from a subsidy to financial claims against that activity. (A long-standing theme of this blog is the pervasive illusion by which a claim on an income from something is equated with the thing itself.)
Daniela defines derisking as, among other things, “the production of inevitability”, which I think is exactly right as a description of the (genuine and important) trend toward endlessly broadening the range of claims that can be held in financial portfolios. But I am not convinced it is a good description of efforts to encourage functioning businesses to expand in certain directions. Even though we use the word “invest” for both.
Conversely, when financing is a constraint, as it often is for smaller businesses and households, it takes the form of being unable to access credit at all, or a hard limit on the quantity of financing available (due to limited collateral, etc.), rather than the price of it. One lesson of the Great Recession is that credit conditions matter much more for small businesses than for large ones. So to the extent that we want to work through financing, we need to be targeting our interventions at the sites where credit constraints actually bind. (The lower part of the top row, in terms of my table.) A general preference for green assets, as in Europe, will not achieve much; a program to lend specifically for, say, home retrofits might.
This leads to the final dimension, what I am calling fine-grained versus broad or rules-based interventions. (Perhaps one could come up with better labels.) While for some people the critical question is ownership, for others — including me — the critical question is market coordination versus public coordination. It is whether we, as the government, are consciously choosing to shift production in specific ways, or whether we are setting out broad priorities and letting prices and the profit motive determine what specific form they will take. This — and this may be the central point of this post — cuts across the other criteria. Privately-owned firms can have their investment choices substantively shaped by the public. Publicly-owned firms can respond to the market.
Or again, yes, one way of distinguishing incentives is whether they are positive or negative. But another is how precise they are — in how much detail they specify the behavior that is to be punished or rewarded. A fine-grained incentive effectively moves discretion about specific choices and tradeoffs to the entity offering the incentive. A broad incentive leaves it to the receiver. An incentive conditioned on X shifts more discretion to the public sector than an incentive conditioned on any of X, Y or Z, regardless of whether the incentive is a positive or negative.
Let me end with a few concrete examples.
In her paper, Daniela draws a sharp distinction between the IRA and CHIPS Act, with the former as a clear example of derisking and the latter a more positive model. The basis for this is that CHIPS includes penalties and explicit mandates, while the IRA is overwhelmingly about subsidies.1. This is reflected in the table by CHIPS’ position to the left of the IRA. (Both are areas rather than points, given the range of provisions they include.) From another point of view, this is a less salient distinction; what matters is that they are both fairly fine-grained measures to redirect the investment decisions of private businesses. If you focus on the vertical axis they don’t look that different.
Similarly, Daniela points to things like the ECB’s climate action plan, which creates climate disclosure requirements for bank bond holdings and limits the use of carbon-linked bonds as collateral, as a possible alternative to the subsidy approach. It is true that these measures impose limits and penalties on the private sector, as opposed to the bottomless mimosas of the IRA. But the effectiveness of these measures would require a strong direct link from banks’ desired bond holdings, to the real investment decisions of productive businesses. I am very skeptical of such a link; I doubt measures like this will have any effect on real investment decisions at all. To me, that seems more salient.
The key point here is that Daniela and I agree 100% both that private profit should not be the condition of addressing public needs, and that the public sector does need to redirect investment toward particular ends. Where we differ, I think, is on which of those considerations is more relevant in this particular case.
If the EPA succeeds in imposing its tough new standards for greenhouse gas emissions from power plants, that will be an example of a rules-based rather than incentive-based policy. This is not exactly industrial policy — it leaves broad discretion to producers about how to meet the standards. But it is still more targeted than a carbon tax or permit, since it limits emissions at each individual plant rather than allowing producers to trade off lower emissions one place for higher emissions somewhere else.
Finally, consider the UK Labour Party’s proposal for a climate-focused National Wealth Fund, or similar proposals for green banks elsewhere. The team at Common Wealth has a very good discussion of how this could be a tool for actively redirecting credit as part of a broader green industrial policy. But other supporters of the idea stress ownership stakes as an end in itself. This is similar to the language one hears from advocates of social wealth funds: The goal is to replace private shareholders with the government, without necessarily changing anything about the companies that the shares are a claim on. 2 From this point of view, there’s a critical difference between whether the fund or bank has an equity stake in the businesses it supports or only makes loans.
To me, that doesn’t matter. The important question is does it acts as an investment fund, buying the liabilities (bonds or shares or whatever) of established business for which there’s already a market? Or does it function as more of a bank, lending directly to smaller businesses and households that otherwise might not have access to credit? This would require a form of fine-grained targeting, as opposed to buying a broad set of assets that fit some general criteria.3 Climate advocate showing to shape the NWF need to think carefully about whether it’s more important for it to get ownership stakes or for it to target its lending to credit-constrained businesses.
My goal in all this is not to say that I am right and others are wrong (though obviously I have a point of view). My goal is to try to clarify where the disagreements are. The better we understand the contours of the landscape, the easier it will be to find a route toward where we want to go.