Does the Credit Crisis Require Policy for Industry?

Now that the credit crisis is having a major effect on global economic conditions, the call for help from the non-banking world is getting louder. The construction and car industries, to name but two, have already sounded the alarm. Does the government need to give in to this? The easy economic answer is to say no; the easy political answer is yes. But of course what is pivotal here are the conditions.

First we’ll look at the easy economic answer that we should not provide support. The support of industry leads to unfair competition because one industry gets support and another doesn’t. This is a matter of false competition because one industry can get capital and use it to do well on the capital market. This does seem to be the effect on the banks that have received support as opposed to the banks that have not.

What’s more, the government is not a sugar daddy with endlessly deep pockets, which makes the choice of which industry to support problematic. The government has an appalling track record when it comes to choosing the ‘right’ companies.

Another problem with support is that it muffles the need for more efficiency and innovation. The longer the support lasts, the more serious the effects are. Ultimately the drip will create dependency. Innovation and competition in the market will lead to the technical ruin of the company in question. This is bad for the company and a waste of the support.

Subsequently, where support has been given, the government is likely to claim some form of control. This creates the risk that some government policy is being implemented in the boardrooms of private companies. This is very undesirable for the companies as well as the people involved, because it will confuse the consideration of interests (see also my ‘Rangers’ column).

And now for the simple political answer that support is essential. The near future will be dominated by cost-cutting, largely by way of redundancies, because of the drop in economic growth or even economic decline. This will affect consumer confidence and consequently producer confidence. We need economic stimulation to stop this downward spiral. This is currently being addressed in The Hague as well as in Europe and the United States. This is being done via demand support (benefits and large contracts) and via direct support to the corporate world (subsidies and participations). Europe will wonder why the banks have received direct support and, for instance, the car industry has not. The employment effects of this sector of industry are of such magnitude that we can’t allow it to collapse. We can also kill two birds with one stone here if we make environmental objectives a condition for the support. In other words, support the car industry and require them to develop cleaner cars.

Both answers thus lead to undesirable results. The political answer prevents potentially large-scale social turmoil, which is the biggest problem with the economic answer. The political answer causes subsidy addiction and false competition, whereas the economic answer encourages competitive business and prevents the waste of taxpayers’ money. Another thing to remember is that it is easier to realize environmental objectives via strict regulation in conjunction with tools such as innovation credit. These encourage market-oriented innovation rather than ‘tinker’ technologies that always need more money because they’re not quite finished yet.

However, is there a middle way? I think so. First of all it is important to cope with the social effects. In the Netherlands we have an extensive social welfare system for this, even though it will never be enough for the people who need it. Secondly, we have to use support instruments that are temporary and don’t encourage false competition. The obvious instruments are credit guarantee regulations, innovation credit, regulations to stimulate investment, reduction of fiscal expenditure for small businesses and reduction in working hours (although this tool is slightly more problematic). These certainly won’t solve all the sociopolitical problems, but they will significantly solve the problem of choice, the dependency problem and the problems regarding innovation and control. This shows that a happy medium is not only possible but, from political and economic perspectives, also desirable.

Oscar Couwenberg

Professor of Law and Economics