Industrial policy – back to the future?

In his book ‘Testimony’, Nicolas Sarkozy, the newly elected French president, wrote that his finest hour as finance minister of France was the government’s rescue of Alstom, a French maker of high-speed trains and telecoms equipment. The company’s banks had refused to extend further credit, and with Siemens – a German competitor – lining up a takeover bid, Sarkozy managed to persuade Mario Monti, the then European competition commissioner, to wave through a S3.2 billion bail-out. Alstom has subsequently taken over Lucent, a US competitor, and French jobs have been secured. Is this just the kind of bold and pragmatic industrial policy Europe needs? Or an example of the economic nationalism that threatens the single market, and with it Europe’s competitiveness?

Both the French and German governments have long been critical of the EU’s state aid rules. Both argue that these rules do not take sufficient account of today’s global economy, and that Europe risks losing out to countries that are more generous with their aid. Germany has regularly criticised the Commission for its alleged failure to appreciate the particular challenges faced by manufacturing companies. And in April, the German government called on the EU to change state aid rules, to allow member-states to ‘match’ financial incentives offered by states outside the EU.

Do the industrial policies of some competitors really justify a return to intervention and more state aid? Much of Europe’s unease centres on China, where it is very hard to say what is state aid and what is not, and where the idea of state support for companies is, in any case, uncontroversial. There is no doubt that trends in bilateral trade give cause for concern. The EU’s trade deficit with China ballooned to almost €130 billion in 2006. Chinese exports to the EU stood at €191 billion; EU exports to China at just €63 billion. With China working its way up the value-chain – so the argument goes – we cannot afford to adhere ideologically to our cherished values of free trade and fully competitive markets.

There is no doubting the challenge posed by China. Its size, and the speed at which Chinese-made goods are becoming more technologically sophisticated, means its impact is dwarfing that of other recently industrialised economies. For an economy at its stage of development to be running a huge trade surplus is almost unprecedented, but for one the size of China to be doing so requires huge adjustments on the part of other economies. Similarly, there is no doubt that the costs of this adjustment are being borne unequally. The renminbi’s link to the dollar means that Chinese imports have become steadily more competitive in recent years, as the US currency has weakened. And with most East Asian central banks intervening massively to prevent their currencies from appreciating, Europe has been left to absorb most of the costs of a weaker dollar.

But state aid for European companies on the grounds that the Chinese, or anybody else, subsidise their companies is not the answer. Companies do not base investment decisions on the availability of state aid. Far more important factors are the proximity to markets, the availability of skilled labour, and the quality of infrastructure and regulation. Rather than harping on about ‘unfair subsidies’ by foreign governments, European politicians should concentrate on boosting Europe’s presence in high-technology sectors. Increased investment in education and skills, together with more support for scientific research, would be a much better use of public resources than more state aid. It is instructive that of the €64 billion paid in aid by EU governments in 2005, just 12 per cent – €7.7 billion – was spent on R&D.

Moreover, state aid for so-called ‘national champions’ nearly always undermines European competitors – in the case of Alstom this was Siemens of Germany and Ericcson of Sweden – rather than non-European companies. If EU governments were allowed to ‘match’ state support provided elsewhere this could trigger damaging subsidy wars between member-states. Companies rarely choose between a location in the EU and one outside of the EU when deciding where to invest. More often than not, the choice is between various EU locations. Finally, loosening state aid rules would threaten the Union’s cohesion. Big, wealthy member-states can afford aid; poor ones cannot. The good news is that the French and German governments will face an implacable opponent to a loosening of state aid rules in the form of the Commission. And they are unlikely to have much success in convincing other member-states, especially the smaller and poorer ones.