Industrial policy – once a key government policy – has been on the wane in recent years.
I think of industrial policy as state-led efforts to: 1) create local jobs and production; and 2) help remedy market failures that keep local producers from moving into new activities or up supply chains. Albert Hirschman’s The Strategy of Economic Development is the key reference in the field. In that 1958 book, he lays out a theory of unbalanced growth, whereby investment that would not otherwise be brought to developed countries. How? Policymakers determine which which sectors and industries complement one another, and give incentives for them to grow together. For example, a forward linkage from Industry B helps support Industry C further along a supply chain, while a backward linkage encourages Industry A that supplies Industry B.
While industrial policy is often associated with countries farther down the development ladder, there is a case for using it in rich countries to promote new green industries.
Why is industrial policy not a major part of the policy conversation these days?
Some of the reason is that economists generally sneer at it.
And some of the reason is structural, as Eduardo Porter opines in today’s NYT:
Manufacturing jobs are on the decline in factories around the world.
“The observation is uncontroversial,” said Joseph Stiglitz, the Nobel-winning economist at Columbia University. “Global employment in manufacturing is going down because productivity increases are exceeding increases in demand for manufactured products by a significant amount.”
The consequences of this dynamic are often misunderstood, not least by politicians offering slogans to fix them.
No matter how high the tariffs Mr. Trump wants to raise to encircle the American economy, he will not be able to produce a manufacturing renaissance at home. Neither would changing tax rules to limit corporate flight from the United States, as Mrs. Clinton proposes.
“The likelihood that we will get a manufacturing recovery is close to nil,” Professor Stiglitz said. “We are more likely to have a smaller share of a shrinking pie.”…
The shrinking of manufacturing employment is global. In other words, strategies to restore manufacturing jobs in one country will amount to destroying them in another, in a worldwide zero-sum game.
Finally, some have worried that policymakers themselves have put up roadblocks to an industrial policy renaissance. Agreements like the North American Free Trade Agreement (NAFTA) have rules that would seem to make it more difficult to use industrial policy, including through lawsuits under investor-state dispute settlement (ISDS).
For folks that worry about that possibility, T. Boone Pickens’ failed NAFTA challenge against Canada’s green jobs policy should come as a relief, as I wrote yesterday.
His ISDS case was one of the first to deal extensively with industrial policy. In 2009, the provincial government instructed the Ontario Power Authority to develop a feed-in-tariff (FIT) program. Such schemes are used around the world, with the core idea being that renewable energy generators are paid a premium on market energy prices. While the generators can be large companies, they can also be individual homes with solar panels. For instance, I have solar panels on my roof that feed into DC’s electrical grid. While it doesn’t supply my full energy needs, I get rebates on about a third of my total utility bill.
Ontario’s FIT policy had a twist: it required generators to purchase 25 to 50 percent of their supplies locally. Such domestic content requirements sometimes help soften opposition to green policy from workers losing jobs in carbon-intensive sectors that are phased out.
Parallel to the FIT, Ontario was making an even bigger deal with a Korean company. As the Mesa Award (discussed yesterday) described:
In August 2008, Samsung approached the Government of Ontario for a special deal on renewable energy. The parties subsequently entered into negotiations, which culminated in the signing of the GEIA [Ontario-Samsung deal] in January 2010. 555. Under the terms of the GEIA, the Korean Consortium was to develop 2,500 MW of renewable energy in Ontario and, importantly, to attract into the Province facilities for manufacturing wind and solar generation equipment and components. In exchange, the Korean Consortium was guaranteed priority access to 2,500 MW of transmission capacity in Ontario… In consideration for its commitments, the Consortium was entitled to a price for its electricity that was higher than that of the FIT producers. This price would be an aggregate of (i) the price payable to renewable energy producers under the FIT Rules plus (ii) an additional EDA [rate] calculated in accordance with the terms of the GEIA…
Are two green jobs programs better than one? Not according to Mesa, who argued that the 2010 Samsung deal reduced the amount of available transmission capacity available to applicants to the earlier announced 2009 FIT program. This in turn led to greater competition among the FIT applicants: Mesa even accused its competitor NextEra of making campaign donations to get access to the remaining transmission capacity.
Such murky fact situations are one rationale for leaving some catch-all imprecise rules in treaties. The idea is this: NAFTA’s negotiators in the early 1990s couldn’t have known that Ontario would have enacted a green jobs policy that enticed foreign investors, only to frustrate them. By requiring Canada to treat investors “fairly and equitably,” NAFTA permits tribunals the flexibility to make sure that the investment promotion objectives of NAFTA are met, even if there was no treaty language saying “make your industrial policy awesome.”
Charles Brower, the arbitrator Mesa appointed to the case, was sympathetic. As he wrote in his dissent…
Canada’s, violation of Article 1105 [i.e. fair and equitable treatment] is that it torpedoed the Feed-In Tariff (“FIT”) program as offered at large…
Moreover, – and this can only be characterized as grotesque – as it actually happened, the Korean Consortium was thereby enabled to acquire low-ranked FIT applicants in order to fill its allotted 500 MW, thereby jumping clear losers in the FIT Program over higher-ranked, but ultimately unsuccessful FIT applicants, due to the reduced available megawattage. This effectively stood the FIT Program on its head, turned it upside down… In other words, while FIT participants were vying for PPAs under the FIT Program, Respondent could hand them to the Korean Consortium on a silver platter…
…by tying a business attraction arrangement to a sweetheart deal guaranteeing, and then actually granting to the Korean Consortium, 500 MW of FIT access for which other companies had been competing on prescribed terms, the Government of Ontario pulled the rug out from under the general FIT Program to the extent of those 500 MW. The sin was in combining the two to the detriment of FIT applicants who were not part of the Korean Consortium and otherwise would have won contracts.
The Pickens-Brower version of fair and equitable treatment would allow tribunals to probe the real world consequences of policies, instead of being tied to the letter of the law.
But Kaufmann-Kohler and Landau (the chair and Canada-appointed arbitrators, respectively) saw the industrial policy justifications much more favorably:
It is critical to note, at the outset, that the arrangement encapsulated in the [Korean] GEIA was not at all comparable with or equivalent to the FIT Program [i.e. program Mesa applied to]. Contrary to the Claimant’s characterization, these were not two competing, interchangeable tracks. Unlike the FIT Program, the GEIA was designed to secure a major “anchor” operator in Ontario, in order to give momentum to its province-wide green energy initiative. But more importantly than this, the GEIA was concerned with local economic development, at a time of economic difficulty. The GEIA entailed a CAD$ 7 billion investment, and the creation of substantial manufacturing facilities over multiple phases; thousands of jobs in the renewable energy sector; and further indirect employment in finance and other service industries, as well as related manufacturing industries. As such, the generation of electricity from renewable sources was only one element of this initiative…
there is no basis to conclude that the GEIA was designed to undermine the FIT Program, and nor would there have been any reason for so doing…
Ms. Lo [a Canadian energy official] further testified that the GEIA was expected to develop the manufacturing industry necessary to support FIT applicants: “[T]he GEIA ensured the establishment of a green energy manufacturing sector in Ontario […] the FIT Program contained requirements that developers source goods and services from Ontario in order to stimulate economic development and job growth. However, at the time, there was almost no local manufacturing available to meet these requirements. The manufacturing facilities required by the GEIA would assist the other renewable energy developers in the FIT Program to meet their domestic content requirements.”
Up until here, the tribunal majority is channeling pure Hirschman.
Yet Pickens argued not only that the Samsung deal hurt him, but that it didn’t help Ontario. As the tribunal recapped…
The Claimant objects that “[t]he [GEIA] did not require any special investment on the part of the Korean Consortium”, calling the consortium’s commitments under the GEIA “fictitious”. It argues that the GEIA’s manufacturing commitments were nothing more than the domestic content requirements of the FIT Program. It further asserts that the “real” obligation of the Korean Consortium under the GEIA was not to create jobs, but merely to identify the jobs which its suppliers would have created, a job growth equally accomplished through the FIT Program’s domestic content requirement. Mesa further observes that Ontario did not distinguish between the FIT Program and the Korean Consortium’s project when ascertaining the number of jobs created.
Could this bring the tribunal majority and minority to agreement? Say the idea of industrial policy rubbed Brower wrong, while it rubbed the majority right. If the differential treatment in the two tracks of industrial policy wasn’t really paying off, maybe all three could agree that Mesa was being treated unfairly for no good reason.
But the tribunal majority did not seem interested in wading into the empirics:
the Tribunal does not agree that the generation and manufacturing obligations imposed on the Korean Consortium were “fictitious.” In fact, it appears that the Korean Consortium had some success in attracting green energy manufacturing jobs to Ontario… Further, and in any event, whether or not the GEIA actually succeeded in its objectives is not a relevant consideration, as long as the conclusion of the GEIA was pursuant to a bona fide policy decision by the Ontario government, at the time… [italics added]
Kaufmann-Kohler and Landau went on to paint a pretty dismal assessment of the Ontario policy roll-out:
It is true that, at the time when the GEIA was signed, the FIT Program was already in place. It is also true that whilst in some quarters concerns were expressed as to the likely success of the FIT Program, others were confident on this…
It must also be noted that Jim MacDougall, the Manager of the OPA [Ontario Power Authority], admitted that when he learned about the GEIA, he was “not terribly pleased by the competing development opportunities that were running in parallel”. He added that in the final months leading up to the GEIA he had realized that the deal with the Korean Consortium would negatively impact FIT Applicants. Further, according to the evidence of Canada’s witnesses, Ontario had no obligation under the MOU [memorandum of understanding] of December 2008 to enter into the GEIA. It could have chosen not to sign the formal agreement in January 2010. And, on one view, this might have seemed to make sense considering that it was known in 2009 that the GEIA would impact the limited available transmission capacity.
Equally, the actual need for an “anchor tenant” could be questioned. By the time the GEIA was signed in January 2010 (as opposed to its precursor MOU signed in December 2008), it was known that the applications under the FIT Program far exceeded the available capacity. Therefore, it could be argued that no anchor tenant was needed. Moreover, Samsung arguably had no experience with developing wind or solar power and did not then operate renewable energy projects elsewhere. The Claimant also contends that there were procedural irregularities in the GEIA (that it was not approved by the Cabinet, and that Ontario’s opposition leader’s request to have the deal be examined by the Auditor General before proceeding was ignored).
Despite all these irregularities, the tribunal majority was not convinced these were a problem for NAFTA compliance:
Be that as it may, these are all policy considerations and questions that were for the government of Ontario alone. It is not the Tribunal’s role to act as an appellate body in this regard, or second guess or weigh the wisdom of Ontario’s decision to enter into the GEIA at the time – even if sufficient renewable energy would possibly have been available through the FIT Program. Rather, it is for the Tribunal to examine whether, as the Claimant alleges, the beneficial treatment was granted to the Korean Consortium arbitrarily, or in any other way that contravened Article 1105. In particular, the Tribunal must determine whether Canada’s conclusion of the GEIA lacked a justification, and whether there was a reasonable relationship between the justification supplied and the terms of the GEIA. For the reasons discussed above, the Tribunal comes to the conclusion that such justification and reasonable relationship did exist. It is a different question, on which the Tribunal does not express a view, whether entering into the GEIA was a wise move under the circumstances. As a result, the Tribunal rejects the claim that by entering into the GEIA, Canada breached Article 1105 of the NAFTA.
The Mesa tribunal’s approach may have been a one-off. A different tribunal could accord more or less weight to real world economic consequences, and could interpret these in the state’s or the investor’s favor. Whether an industrial policy in a developing country would have been treated so deferentially is also an open question. But it suggests that at least some arbitrators are unwilling to second guess industrial policy – not matter how well or poorly executed.
Todd N. Tucker, PhD 