Sunday, April 27, 2008

Do governments make good entrepreneurs?

I liked the final sentence in Dani Roderik’s book:
“Perhaps most difficult of all, economists will have to learn to be more humble!” (“One economics, many recipes”, 2007).

However, this is not a book by a disciple of F. A. Hayek warning about the “fatal conceit” involved in governments’ attempts at economic planning. Although Dani Roderik is not an old style economic planner he is, at best, equivocal about the benefits of economic freedom in facilitating economic growth.

Many of the criticisms that I would like to make of this book are contained within it. The author makes clear that he is fully aware of many of the objections that others will raise about his views. In brief, he argues that despite all the legitimate concerns that economists have about government failure the best way for governments to cook up economic growth is to develop their own home-grown recipes to provide necessary incentives – including by correcting alleged market failures.

The part of the book I found most interesting was the discussion of what the author describes as “information externalities”. The discussion begins by indicating that the author is considering the role of entrepreneurs in experimenting with new product lines – which involves, among other things, discovery of information about technologies, cost structures and profitability. The author refers to this as a process of self-discovery. He writes:
“When we put ourselves in the shoes of an entrepreneur engaged in cost discovery, we immediately see the key problem: this is an activity that has great social value and yet is poorly remunerated. If the entrepreneur fails in his venture, he bears the full cost of his failure. If he is successful, he has to share the value of his discovery with other producers who can follow his example and flock into the new activity. In the limit, with free entry, entrepreneurship of this kind produces private costs and social gains” (p105).

In reading this my first thought was that even though the economics is dodgy, at least it makes a change from the argument that first-movers enjoy huge advantages and make unwarranted profits.

Then, on the next page I read:
“The first-best policy response to the informational externalities that restrict self-discovery is to subsidize investments in new, nontraditional industries”.

I agree that it is quite plausible that in many low-income countries entrepreneurs can expect little profit in return for their efforts in discovering new opportunities. It seems more likely, however, that the reasons for this would have to do with predatory behaviour, of one kind or another, associated with the tax and regulatory environment than with market competition. If so, the best policy response would be to deal with the predatory behaviour rather than to label the problem as an information externality.

Dani Roderik argues that his first-best strategy (investment subsidies) is not feasible, so governments should get involved in winner-picking – in effect, taking on part of the entrepreneurial role. He acknowledges that some of the investments promoted by governments will turn out to be failures. He suggests, however, that if there were no failures this would mean that the program was not sufficiently aggressive. A good industrial policy will ensure that failures “are phased out”.

Unfortunately, that is where the discussion ends. In the course of the discussion readers are given some examples of entrepreneurial efforts of governments have apparently succeeded. The discussion would have been more persuasive if the author had included examples of governments that have had no difficulty in phasing out the failures that have arisen as a result of their winner-picking efforts. I suspect, however, that he would have had difficulty in finding such examples.

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