When governments fund decades-long loss-making ventures that expand the economy’s production capabilities, we call it industrial policy. When a billionaire does it, we say it is markets at work. Dr Cameron Murray examines this economic fallacy.
Elon Musk has lost billions of dollars for nearly a decade trying to make electric vehicles at Tesla in a way that has never been done before.
In the new tech-billionaire space-race, where Musk has also been active with his Space X company, his competitor Blue Origin, run by Amazon CEO Jeff Bezos, has been running at an enormous financial loss, requiring Bezos to sell over a billion dollars of Amazon stock a year to fund his space venture.
In both of these sectors, electric vehicles and space transport, there is no guarantee of any long term profit – there are threats from multiple new entrants as well as incumbents in both sectors. Yet billions of dollars are being poured into these experimental investments.
When governments fund similar decades-long loss-making ventures that expand the economy’s production capabilities, we call it industrial policy. When a billionaire does it, we say it is markets at work.
But there is nothing “market like” about long-term, long-shot, gambles like these. This behaviour falls outside any core economic theory about the efficiency of markets in allocating resources. After all, most billionaires don’t spend their fortunes on privately-funded industrial policy with only a fleeting chance of any future payoff.
If a country wishes to expand its production capabilities, it seems foolish to rely on the type of luck that the United States finds itself with. Australia’s billionaires, for example, are busy fighting to keep their generous tax loopholes and government protected monopolies, innovating more in their lobbying and corruption than in production.
Australia’s rich list is peppered with billionaires who made their fortune on the back of favourable government deals that handed them economic windfalls. There is barely a single innovator amongst them.
It should be no surprise then that Australia’s multi-decade de-industrialisation has finally become a mainstream political topic. According to research from Harvard, in the 20 years prior to 2015, Australia dropped from 49 to 77 in the country rankings of the complexity of their production capacity – that is, how advanced and diverse the county’s manufacturing capabilities are.
And our lazy billionaires were nowhere in sight.
Despite the benefit of billionaire industrial policy, and a stable position in the country ranking of economic complexity, Donald Trump made it to the White House selling the message that manufacturing still matters in the United States.
So what does effective industrial policy look like when it doesn’t rely on lucky billionaires whose ambitions may not always match those of the rest of us?
The answers are simple. If society accepts that losses from some experimental investments to make the impossible possible are worth the risk, it doesn’t matter who takes the losses – the public via government, or billionaires. After all, the macroeconomic implications are the same; real resources, the land, materials, human labour and its brainpower, are all diverted from productive uses to high-risk high-stakes experiments, be it in space, or the electrification of transport.
Typically, governments have been one of the few large organisations able and willing to make large long-term losses for a small chance of a broad long-term gain. There have often also been military motivations lurking in the background of such investments, but this need not always be the case.
NASA’s spending on the original space race, for example, was itself an extensive piece of industrial policy. NASA’s spending peaked at $5.9 billion in 1966, which was 4.4% of the federal budget, with limited direct commercial return. The graph below shows just how abnormally large the spending program was in the 1960s, and a back-of-the-envelope calculation shows it to be about 100 times larger than losses being made in the current billionaire space-race.
In effect, the 1960s spending on the space-race was a decade-long loss-making venture undertaken by the US government that radically expanded the production capabilities of the country. Indeed, if not for this earlier period of enormously costly industrial policy, the current private space-race would have little reason to exist.
What happens with these types of experimental investments is that any future benefits often emerge indirectly. The materials and computer technology developed in the 1960s space-race has dispersed through the economy creating broad and indirect benefits that are very hard to see, but that nevertheless have expanded global production capabilities.
The other thing that competent governments have traditionally been good at is overcoming coordination problems that would stifle innovation happening in any one particular area. What good is a boom in private flight, for example, without air traffic control and a system to coordinate it? What good is developing the capability to build railroads without the ability to acquire the land to put them on?
Here again we see billionaire industrial policy playing this coordinating role. Tesla has been investing in both new electric vehicles, and the large infrastructure network of high-speed charging stations necessary for them to become a fully useful replacement for the petroleum-fuelled vehicle fleet. And again, like all vehicle manufacturers, they are relying on earlier public investments in the coordinating system that is the road network itself.
The trick to understanding the logic of industrial policy is this. Markets won’t automatically experiment with high-risk new investments with a fleeting chance of any future direct return. Somewhere, someone must make losses for a long time while experimenting with new types of production knowing that there may never be a direct future return. Somewhere, someone must coordinate to avoid external conflicts that can arise and stifle new production.
With renewed interest in manufacturing, renewable energy, and space, governments can take on these traditional industrial policy roles while also supporting billionaire industrial policy if it emerges as well. There is no conflict. But if we want to build things that have never been built before, someone has to take on the short term economic losses to get there.
How do you spend your days?
Writing mostly. Also teaching the bright minds of tomorrow realistic economics at the University of Queensland. Chasing the kids. Sometimes time for football and rock-climbing.
Why is this important to you?
The political environment in the developed world is rapidly becoming more polarised than it has been for over half a century. I see this as a dangerous situation that makes it harder for people to get good information that is not tainted with views from the extremes.
What drove you to focus on economics. Was there a particular moment you can remember that led you to this field?
Observing the wilful blindness within large companies and organisations who seemed to have a knack for ignoring the obvious sent me crazy! As I began to see this more in our public policy debates I realised how much value can be gained by taking a step back and having an objective and systematic look at the world. Economics allows you to do this. If you can survive the first few years of indoctrination and keep your open mind, there is a lot of useful research going on in the field.
What drives you professionally?
Making a difference. I actually was close to leaving economics to become a medical doctor in 2012 so I could at least know I was helping someone. But I decided instead to stay in economics and focus on corruption and related topics that I knew might not make a direct difference to many people but could make a systematic difference if I could share the knowledge widely.
In your opinion what are the three biggest problems facing the developed and developing world?
For the whole world, the number one problem is the ongoing battle over the economic surplus.
Institutions that have funnelled wealth, income, and power, up the distribution are reaching their social limits. Between nations, decades of trade imbalances will likely reverse as previously rising nations stabilise, and new nations embark on rapid industrialisation. The losers from major changes to the distribution of global wealth will not be happy.
If you hadn’t become an economist what would you have done?
Become a medical doctor.
What led us to this moment in history?
Chance and luck, just like always. Though I do believe there are long term patterns that repeat in the great arc of civilisation.
What are the lessons we failed to learn during and since the 2008 crisis?
That finance is not an output of the economy, but an input to it. We had a chance to go back to basics and remember that the real economy is about producing things that people value.
Can you list some ‘baby steps’ out of the current economic mess?
Boost public spending on tax authorities so they can bring international firms into line. Vote out major parties to allow the diverse voices of the minor parties to rise up and reset the scope of public debates.
If you were a President / Prime Minister what would your first three pieces of policy be?
First, ensure that when political decisions result in windfall gains to private entities that these gains are taxed or sold by the government to recoup their value. Second, create a public bank with a mandate for investment in value-added export industries and renewable energy generation and distribution.
Third, ratchet up taxes on land, wealth, and inheritance.
Tell us something you have been wrong about?
I never thought the Sydney property market would be at a $1 million median price by 2016. I thought Trump would do better than expected in the election, but not win it.
Name the book that changed you.
Ultra Society by Peter Turchin. It made me stop thinking of economic growth as a competitive process, but a cooperative one. As an economist trained to see competition and understand its merits, I have now broadened my view to see how in fact competition and cooperation work together.
What would you do differently if you were to start all over again?
Nothing. Life is a lesson. It’s not something to be optimised. I want to make all the mistakes again… maybe a few more as well.
Give our readers, members and subscribers a piece of advice that has served you well.
From my Dad, about taking on new and challenging projects - “If it was easy, everyone would do it.”
Anything you would like to plug? Now is your chance.
My personal blog is fresheconomicthinking.com. Also, read macrobusiness.com.au, and follow me on Twitter @DrCameronMurray.