- Cross European differences in government models

1. MGTECON 580: Class 2 The size and scope of Government - Cross European differences in government models - Economists’ view on Industrial Policy EU versus US - Indicators on the size of “government” - Empirical facts and trends - The rationale for government intervention in market economy - Politics vs. economics - Industrial policy: a variety of definitions - The EU framework - Examples and actors on the EU level - Should government engage in Industrial Policy at all? - Does business like government intervention? Conclusion:Government shapes competitive environment; this impacts (to the good or the bad) on firm performance

2. Cross European Differences in Government Models The French model: - Enlightened state, elite schools for bureaucracy and business - Sectoral planning, cross ownership, European-lead projects The UK model: - Liberalization and privatization; theory-based “new” regulation - Competition policy, corporate governance The German model: - Shaping the competitive environment; sector neutrality - States, banks, trade unions; two-tier boards The Southern model: - Over regulation without monitoring - Inconsistent approach limits catching up The Northern model: - Paternalistic, egalitarian, high cost - Efficiency-focus plus large firm bias

3. Economists’ view on Industrial Policy: EU vs. US Survey: 101 economists Industrial Policy network EUNIP 24 US/CAN/UK; 70 Europe (predominantly EU) “The government interference in manufacturing in the US and in Europe differs in style, but not in its extent” Remark: Completely agree is 1; completely disagree is 5

4. Economists’ view on Industrial Policy: EU vs. US cont. Examples for US interventions: - Import duties to save ailing steel industry - Tax rules favoring exports - Anti-dumping rulings - Bailing out of Chrysler, Savings & Loan System - Tax money for tobacco planting - Defense and research money - Subsidies for Japanese car transplants Evaluation: Policy interference is higher in Europe, but it’s not “all vs. nothing”

5. Indicators on the size of government Most used indicators (2000) A bunch of statistical problems - Double counting of expenditures - OECD and EU numbers different - Tax deductions vs. expenditures - One-time revenues (privatization, telecom auctions) - Federal, state, local budgets; off-budget funds Full economic assessment depends on activities: - Defense - Health system - Research and Development - Education - Security - Poverty, unemployment prevention

6. Empirical facts and trends Secular increase (Wagner’s Law) of government share in GDP Positive relation to per capita GNP - Causality direction from income to government - Outliers: CH, US Surprisingly weak impact on growth - Importance of activities Trend reversal: eighties and nineties Policy: since 1980/1990, smaller is better, but… - Actually maximum 1993: 52.4% - 1990 - 2000: from 48.4% to 47.1% - 1.3% 12% Ireland (to 33%), - 8% Netherlands (to 47%) German +4% to 48.4%, F +2% to 52.9% Success depends on growth acceleration The future? - Privatization of railroads, health, pensions, defense, jails - Or evaluation on merits?

7. The rationale for government intervention in a market economy? 1. Correction of market failure 1.1 Monopolistic distortion - Rent are maximized if p = MC = AC Monopolies, oligopolies, monopolistic competition p>MC 1.2 Natural monopolies - Market too small for more than one firm 1.3 External effects - Firms invest but do not fully profit from R&D - Firms pollute, but do not carry full costs 1.4 Asymmetric information - (Small) firms are sound, but do not get credit - Cars are lemons, but buyer can’t know 2. Provision of public goods - non payers cannot be excluded from consumption, be it out of technical reasons or cost inefficiency 3. Social preferences - Government/electorate overrules private preferences - Health, education 4. Macroeconomic reasons - Cyclical dampening - Promoting growth and competitiveness

8. Politics vs. economics The necessity of state interference in unquestionable - Intervention in 1 increases welfare - Intervention in 4 increases growth and stability - Intervention in 3 is ordered by electorate - Increases in 2 can serve all goals or be “too much” There are alternative techniques to reach goals - setting price, splitting firms, enabling entry - competition for markets - public production, provision, removing obstacles There are questions about the size of problem, when the intervention should start - market failure has to be compared to government failure - regulation authority can be seized by regulated firm - special interests are extremely good organized Government priorities (agendas) can be very different - lower interest rates for small firms or - reducing the risk for new technologies or - untaxed benefits for executives (stock options, luxury expenditures) The challenge: Does government intervention promote growth or deter business?

9. Industrial policy: a variety of definitions The comprehensive one: - subset of interventions that might affect a company The old European one: - promoting structural adjustment necessitated by changes in comparative advantage The new European one: - measures increasing productivity and competitiveness of industry American fear, European reality, East Asian hope: - targeting at “strategic industries” steel, ships, textiles (passive) defense, air & spacecraft (procurement) pharma, biotech, ICT, content, design, (picking tomorrow’s winners Remark 1: Never included: fiscal policy, monetary policy, environmental policy Remark 2: Included in wider definitions: regional policy, corporate governance, competition policy, regional policy

10. Industrial policy: a variety of definitions The core rule for the competitive framework: Subsidies are forbidden, if they distort trade, and no exception appliesTreaty of Rome, Art 8 Specific definition for Industrial Policy: Amsterdam Treaty Art 157 - IP ensures conditions necessary for the competitiveness of the community’s industry - in accordance with a system of open and competitive markets The principal exceptions - regional development - projects of common European interest (Airbus, Ariadne) - serious disturbance in a member state (after oil shock 1973) - aids not effecting trade conditions (most often used) National investment promotion programs have to be “notified” - specific cases have to be reported or are investigated into by the commission - quantitative limits for exceptions: maxima and extra points Extent of state Aid EU (Kuyper in Darmer): Between 1 and 2% of GDP with declining tendency - excluding agriculture, excluding cohesion and social funds, tax exemptions

11. Examples and Actors on the European Level Examples - 25% of investment according to regional map - 50% in objective 1 regions (< 75% per capita income) - 75% for research spec. if pre-competitive - 15% for small firms even if not in preferred region - 300.00 Euro (cumulated 3 years) have not to be reported - 30% for environment even if not in preferred region - 75% for information technology related expenditurs The core actors - DG ENTERPRISE - DG COMPETITION - DG INTERNAL MARKET The final goal of Industrial Policy as defined by EU: Mission statement of DG enterprise: Increasing European Competitiveness “to enable enterprises to strengthen their competitiveness, grow and develop in a way that is compatible with the overall EU goal of sustainable development” Strategic goal set at European Counsel in Lisbon To become the world’s most competitive and dynamic knowledge-driven economy

12. Does business like government intervention? Disliked: Business taxes Restricting rules Appreciated: Stable environment Good education, research basis, legal system Divided opinion depending on position: Entry regulation: insider vs. outsider Competition policy: Microsoft vs. Java Subsides: in general less subsidies vs. lower taxes Evaluation: In general not, in specific cases very much

13. Should government engage in Industrial Policy at all? 101 economists Industrial Policy network EUNIP 24 US/CAN/UK; 70 Europe (predominantly EU) “The best Industrial Policy is no Industrial Policy?” Remark: Completely agree is 1; completely disagree is 5

14. Economist’s view on the efficiency of mergers 101 economists Industrial Policy network EUNIP 24 US/CAN/UK; 70 Europe (predominantly EU) In the long run mergers are not efficient Remark: Completely agree is 1; completely disagree is 5

15. Conclusions In all market economies, government intervenes, albeit at a different size Some of the interventions are welfare maximizing and have to be favored by most market friendly economists and by business In absence of a consistent approach vested interests and lobby groups determine the agenda Industrial policy often intervenes against demand trends and try to preserve past structures Country models are different, the specific model decides about success Interventions are decreasing, instruments are optimized (auctions) The emphasis shifts from sectoral interventions to encouraging activities and increasing competitiveness Competition policy is more lenient in Europe, but neither US nor EU act despite of the convincing evidence on the unprofitability of mergers Evaluation: Knowing the differences in the rules and making use of them greatly impacts on firm performance

16. Divides in Industrial Policy (A1) Indicative planning vs. mandatory planning Passive vs. active Troubleshooting - targeting future growth industries Horizontal vs. vertical Targeting industries - promoting activities Output goals vs. resource development Removing obstacles to change vs. lowering the burden of change Competitive environment versus part-time shelter Targeting industries or picking the winners Tendering research money - setting up trans European firms Encouraging size, mergers or monitoring competitive variety

17. Instruments of Industrial Policy (A2) Public ownership Subsidies Tax exemptions contingent on activities Tax structure Infrastructure Competition rules