World Bank, Where’s Your Industrial Policy Mea Culpa?

After decades of bad advice that led many developing nations down the wrong path and ignored evidence against neoclassical dogma, the World Bank should have the courage to admit it was wrong.

The wonkosphere was in full tizzy mode over the last month because, miracle of miracles, the World Bank supposedly now says that industrial policy is not akin to economic malpractice. For the high priests of neoclassical economics, for whom the World Bank was a sacred temple, there was nothing that could forfeit your standing as quickly as failing to decry industrial policy as utter idiocy, practiced by cranks and charlatans. (I, for one, have long welcomed my charlatan status.)

So, thunder struck, and lo and behold, the temple on high now appears to concede that industrial policy might be okay, at least for lower-income nations. The new tablet, in the form of a report titled Industrial Policy for Development, is supposed to represent a turning point—and an apology from the temple hierarchy for getting it wrong.

Like I said, the World Bank’s departure from orthodoxy created panic among the faithful. Free market ideologues are pissed:

• The Wall Street Journal writes that the “World Bank embraces industrial policy, abandoning three decades of stigma.”

• Reason, the nation’s largest libertarian magazine, says that the World Bank “used to champion markets. Now it’s surrendering to state-led industrialization”; oh, the horror.

• The Washington Post’s now free market-focused editorial board is appalled, declaring that “industrial policy won’t work.”

Okay, calm down. Don’t get your knickers in a twist.

First, if the journalists had actually read the report, they would have found that it is largely a wolf in sheep’s clothing. Not to worry: The World Bank is still committed to its old ideological ways. Sure, it writes that nations can try industrial policy. But it also claims that even if they get it right, it has almost no positive effects, apparently boosting GDP by at most 1 percent.

Second, if countries are desperate for growth, the report says to go ahead and dabble in industrial policy for a few years—but then, by all means, get back to the tried-and-true free market “fundamentals,” like macroeconomic stability and a good business climate.

The report’s key box on industrial policy advice says it all. In order of priority, governments should:

1. Not pursue industrial policy; they should just focus on getting the fundamentals right.

2. Spend little money if they insist on going down this path (that way, they’ll do the least harm).

3. Provide market incentives.

4. Not engage in macroeconomic policies like exchange rate devaluation, even if it makes their manufacturing sectors uncompetitive.

And amazingly, the report states, “More research is needed to understand whether and when general tax credits for research and development in private businesses translate into valuable inventions.”

What? You mean more than 30 years of research, with hundreds of academic studies showing that they do work, doesn’t suffice? Clearly not to the World Bank, which seems to be waiting for a study that says R&D credits don’t work.

Plus, the Bank suggests that while countries may want to pursue industrial policy, they are likely too incompetent to execute it effectively. The fact that some, if not many, governments have not gotten industrial policy right—and the theory and evidence of what constitutes doing it “right” are very clear—leads it to conclude they should avoid it altogether.

This is a bit like saying a bunch of countries got monetary theory wrong, so get rid of your central bank. Or, since various nations failed to properly support education, you might as well do away with your education ministry.

The World Bank chief economist closes his foreword by essentially saying: If you must do this malpractice, don’t say we didn’t caution you first. He writes that the report “warns every government—poor, middle income, or rich—that when it comes to industrial policy, its reach can easily exceed its grasp.”

You can almost hear their anguish and moans. “Damn, we have to say something good about industrial policy. All the countries we help are demanding that we give them something. But we really don’t want to.” You could see them working till the pips squeak.

Let’s be perfectly clear. Despite the patina of economic science, this is simply ideology speaking. Nothing more. The Bank believed then, and continues to believe now, that market failures are very rare (except perhaps pollution), and that government failures are endemic. So, there is nothing countries can do except get out of the way and enable the full working of market forces.

This ignores the theory and evidence that demonstrate why this is wrong, as generations of non-neoclassical economists have advised. These endogenous growth economists, neo-Schumpeterians, institutionalists, and innovation economists have a long and distinguished body of academic work that rebuts and effectively refutes this ideological position. Amazing scholars like Sidney Winter, Richard Nelson, and Richard Lipsey have been treated as heretics by the priesthood and systematically excluded from the establishment.

Which gets me to my main point: World Bank, you screwed up. Not just a bit, but a lot. You led so many countries down the wrong path, and that led to limited growth. Countries that ignored you, like Taiwan, Singapore, South Korea, and, of course, China, prospered.

Chinese policymakers embraced national developmentalism based on Friedrich List and Joseph Schumpeter, rejecting Adam Smith and David Ricardo. As a result, they not only grew dramatically but also sucked up much of the world’s manufacturing oxygen and deindustrialized large parts of the developing world, probably for at least the next half century.

Indeed, China is trying to consign the Global South to Ricardian comparative advantage: Sell us your food, minerals, and energy, and we will sell you advanced goods. To which World Bank economists cheer and say, “Ah, see free markets and globalization at work.” At least the IMF has a few economists who really understand industrial policy and are allowed to write about it.

It’s not great to be wrong for a generation. But at least have the courage to say you were wrong—which this report fails to do.

Let’s be honest: The World Bank won’t change its ideological religion or the terrible advice it continues to give. Only the creation of a new institution, guided by new growth theory and national developmentalism, will result in change. And that certainly won’t happen as long as China and the United States control the Bank.

China wants the Bank to continue to preach Ricardian economics so it doesn’t face competitors in the Global South. And the U.S. is too ideological to know that neoclassical economics is a failure. So, the result is that the Global South turns to China for advice, seeing how it was one of the few countries that broke out of the low-income trap. Except they don’t know that China has no interest in helping them. And developing nations keep struggling.