Should we support manufacturing as government industrial policy?

Earlier this year, Gene Sperling gave a speech about why subsidizing manufacturing is good policy, not a market distortion that is more likely to do harm than good net net.  His main point was about positive externalities.  Since externalities are a subject that is near and dear to me and a frequent topic of this blog, I put some serious thought in to his message.

Quick basic background.  There are two reasons for sticking to free market principles and two reasons to violate them.  If you are a libertarian by religion, then there is never a reason to deviate even a little.  When it is a religion – well, ‘nuf said.  On the other side, we look for externalities.  When a person or organization is able to get the benefits of an operation but pass off the costs onto someone else, they gain an unfair advantage.  In these cases it makes economic sense for society to add those costs back on through regulation, taxes, or other mechanism.  This is where environment regulations, labor laws, disclosure rules, accounting standards, etc come in. 

And when a person or organization’s acts create positive results for society, it makes economic sense for society to encourage it through subsidies, tax credits, and regulations.  This is where the earned income tax credit and charitable contribution tax deduction come in.

The problem is that when government intervenes, they often screw it up.  For decades, government thought the mortgage deduction had positive externalities because homeowners were more likely to keep up the house and the neighborhood.  But they didn't see the negative externalities and unintended consequences which magnified the real estate bubble and subsequent burst.  Government industrial policy often picks specific winners and losers, which skews the market.  Corn subsidies and oil exploration tax credits come to mind.  It is better to create more general interventions like an R&D tax credit that is open to every business in any industry and any domain. 

So where does manufacturing come in?  If the government supports manufacturing over other kinds of business (service, agriculture, natural resources, science), will that create a distorted market and/or are there positive externalities that justify the distortion?  Gene Sperling suggested that there are.  Manufacturing creates positive externalities in the form of innovation, spin-off jobs, supplier jobs, new technology expertise, and more.  This happens in greater degree than in other sectors and therefore justifies the distorting nature of a targeted subsidy.

The problem is when lobbyists get their hands on the final regulations and skew the benefits towards one manufacturing sector over another.  Cars over trains.  Tablets over ultrabooks.  OLED lights over fluorescents.  Or whatever. This often skews the market to the point where the negatives outweigh the positives.

My thoughts on this won’t surprise any of my regular followers.  The idealist in me knows that Sperling is correct in theory and that supporting manufacturing could lead to these positive externalities.  But the realist in me knows that it not going to happen quite as purely as it should.  And the result might not be net net positive.  Shame too, because we could use a good boost to jobs right now.