A smart industry development policy can be pursued

The EU as an economy is lagging behind because its competitiveness is falling, for example compared with China, believes Stefano da Empoli, the head of the Institute for Competitiveness in Rome.

CE Financial Observer: Alongside innovation, competitiveness is one word that is constantly repeated by politicians and economists. It is clear what it means in the case of companies, but how should we understand this concept in the context of states?

Stefano da Empoli: There is no clear definition of what it means that a given state is competitive. It could be said that a competitive state is simply one that is quickly developing.

At the expense of others?

No – together with others. As an economist, I believe that the greater competitiveness of state A does not necessarily have to mean a lower competitiveness of state B. This is different than in the case of competing companies. Economic development is a win-win situation.

I once spoke with former Finance Minister of Greece Yanis Varoufakis. He had a different opinion. He believed, for example, that Italy was admitted to the Eurozone because it would pose a threat to the competitiveness of Germany if it remained outside. That would be a result of keeping the country’s own currency, which would enable its devaluation in order to achieve an advantage in exports. The Germans couldn’t allow Fiat to beat Volkswagen.

It’s true that many politicians, and even some economists, believe in the beneficial power of devaluation. But it is a myth. Monetary policy cannot permanently increase competitiveness. It can be manipulated in the short term, but this effect isn’t particularly strong, and ultimately could even be destructive. Let us take a look at the experiences of the countries of Latin America. The competitiveness of an economy is increased by reforming the institutions within which it functions, and in this way stimulating the supply, rather than the demand. Competitiveness goes hand in hand with productivity – it enables its growth. Unfortunately, the countries of the EU have leaders who do not fully understand this. Because of this, after the year 2000 productivity in the old EU countries was either in stagnation or even declined, and only recently started to grow again.

The belief that the competitiveness of a national economy can be built with the use of protectionism is becoming increasingly popular. Would you agree with that?

That depends…

I expected a firm protest from a graduate of a strongly pro-market institution such as George Mason University!

We need to distinguish between the various types of protection. I am a firm believer in the free market, that is clear, but I do not believe that a policy intended to support industry is completely pointless. Of course, provided that it is well understood. I am an opponent of active protectionism, i.e. the restriction of access to our market for companies from abroad or subsidizing one’s own companies. However, I understand passive protectionism which simply aims towards a symmetrical treatment by economic partners in the international arena. The point is that if some country is using protectionist measures against you, you should respond in the same way, based on the principle of equality.

So, if China imposes a duty on, let’s say, Polish milk, should Poland impose a duty on Chinese rice?

No, that’s too much of a simplification. It all depends on the specific situation – we must study each case and respond in an adequate, non-exaggerated manner.

And what do you think about enlightened protectionism represented by professor Justin Yifu Lin, the creator of new structural economics, which involves government support for sectors with so-called hidden comparative advantages?

I’m skeptical when it comes to the government’s ability to identify the sectors of strategic importance for the development of the economy, and especially to find these potentially strategic sectors which no one else, no private investor, has yet noticed.

Yifu Lin gives an example of India which supported the development of internet infrastructure to enable the development of various types of call center and remote IT services, which the Indians have been providing, i.e. to the Americans.

As I said earlier, I don’t deny the necessity of some kind of industrial policy. However, I am a supporter of measures which do not discriminate against this or that company, i.e. instruments that are applied in the same way for everyone. I’m talking about tax incentives and support for research and development activities. Based on the Italian experience, I can tell you that when a politician starts to choose companies worth supporting, then he selects them based on the criteria of personal connections or political interest, rather than economic criteria. This is not an efficient allocation of capital.

You talk about tax incentives, probably meaning various kinds of tax relief. Don’t you think, however, that the best incentive would be to reduce taxation for everyone?

Of course, a flat tax for everyone would be the best, but we encounter a problem here: government expenditure. It is high and the government has to finance it somehow. I’m a realist and because of that I believe that when we have a choice between a system with high taxes and a system with high taxes and tax relief, the latter system is better. That is because the former reduces the level of investment in the economy and reduces its rate of growth. Of course, an industrial policy cannot be reduced solely to fiscal stimuli and funding of research and development. The government is responsible for providing companies with a good legal and administrative infrastructure, preferably based on digital networks. It is also responsible for an education system adapted to the needs of the market, for good legislation and fair courts.

So, it’s simply about an efficient state?

We could put it this way.

Let us get back for a moment to the relationship between competitiveness and productivity. France, a country which is not typically associated with dynamic development and competitiveness, has a very high rate of productivity per employee, at the level of the United States. How can we explain that?

Well, it’s a kind of a statistical illusion. France artificially limited the working time with a variety of regulations. As a result, a smaller number of workers work shorter time and perform the same tasks. Mathematically speaking, their productivity had to increase. However, in the United States, with a similar productivity per employee, more people are working for a longer period of time. That is why the United States are growing and France is in stagnation.

Does the level of social expenditure in a given country influence competitiveness?

Again – that depends.

And again – I didn’t expect that answer from you. Most supporters of the free market would say: of course, it does. For example, by reducing it.

It depends which expenditure we are talking about. For example, social expenditure includes expenditure on health care, and when health care covers everyone, then it increases productivity and competitiveness rather than reducing it. It simply keeps employees in good shape, as a result of which they can do their jobs more effectively. This is a matter that requires a lot of nuance – for example, expenditure on health care in the United States is very high, but its quality and efficiency is not the best. Another issue is retirement and various types of benefits. Firstly, they are too generous to be financed by taxpayers. Secondly, if the resources allocated for them remained in the hands of taxpayers, they would be invested in a more productive way. I don’t believe that retirement pensions shouldn’t exist at all, but I believe that they should be adapted to the real capabilities of the economy. When it comes to my country, Italy, we should raise the retirement age and give people incentives to enter the labor market at an earlier age than they currently do.

And does education, as we are being persuaded, really improve the competitiveness and the productivity of the economy?

The statistics are pretty clear – the higher your education, the higher the future income. Of course, in individual cases some people waste time studying something different than their future field of work. As a university lecturer, I have some students who should never have gone to university at all. I understand the criticism of the current system – it does not utilize its full potential. One problem is, for example, the detachment of the curriculum from the real world, from practical matters. Meanwhile, the more practical tasks are done at school, the better it is, the better it teaches you to prepare for real life. The point is for schools – starting from the earliest years – to offer a comprehensive program of traineeships, projects, workshops and volunteer work. The Germans are great in this respect with their technical schools. Did you know that Germans are on average worse educated, i.e. they have less education, than the French? And yet their economy is much stronger and more dynamic. On a side note, for the past 20 years we’ve been reforming the Italian economy in a similar vein as the Germans and I hope that it will produce the expected results. Unfortunately, we still have problems with digital competences, which suppresses our potential.

Your views are quite unorthodox for a supporter of the free market. And what would you say about the impact of public debt on the competitiveness of the economy?

My views are fairly standard in this case: excessive debt is an enemy of competitiveness. We don’t see this yet, because central banks use quantitative easing, which masks the problem, but you cannot do that indefinitely. At some point, the interest rates will rise firmly and the issue of excessive debt will come back with increased strength.

The debt crisis in Europe has resulted in proposals of so-called structural reforms which have been developed, among others, in Brussels. They emerged along with the push towards the so-called policy of austerity – is this policy effective?

I think that in the short term this may be painful, but it is necessary, and it is perhaps the only possible solution to the problems that have been plaguing the economies of the south of Europe. But of course, certain things associated with austerity or the restructuring of Greece’s debt (the country with the biggest problems) should have been sorted out more swiftly. A considerable amount of time was lost on senseless bickering, which additionally increased the uncertainty in the market and exacerbated the situation.

Getting back to Varoufakis – he claimed that the European elites knew very well what should be done from the very beginning of the crisis, i.e. that a part of the debt should be written off, so the debtor would not bleed out. However, for political reasons this was resolved through additional bailouts conditioned on the implementation of reforms that lacked public support.

I understand that this mechanism is quite controversial, because it has some characteristics of blackmail, but let’s not forget that debtor states must take responsibility for their policies. For the global economy to work, debts simply must be repaid. It’s true that Greece is only 3 per cent of the GDP of the Eurozone, but this is a matter of principle. Of course, in specific cases we can discuss the form of repayment, in order to avoid – as Varoufakis put it – bleeding the debtor out. But an unconditional writing off of debt is pretty reckless. Incidentally, Greece is slowly getting back on its feet and the situation is less critical than even a few years ago. I am convinced that both Brussels and the Greek government share some of the blame for the delays in the implementation of reforms in that country.

Let’s move on to the competitiveness of the European Union as a whole. It seems that the strategies aimed at increasing it are not working, is that right?

Unfortunately, we are now even far behind China. Let’s look, for example, at the research on artificial intelligence, in which China is becoming a global leader. This is the future.

In that case, what are the chances for the EU to catch up?

I’m not optimistic here. For industrial policy to be effective, it must be carried out at an appropriate scale. Europe is fragmented and divided, so it is difficult to implement development programs consistently. In the EU, we need better coordination in matters such as market and legal standards and norms, the security of citizens, data security and the digital ecosystem. These are the foundations. That and, of course, research and development. We need several strong European research centers in different areas, instead of pretending that each country can afford to do this on their own. So, we would have to create some kind of a research union, but there is still a long way to go in this regard.

Stefano da Empoli is an Italian economist, the head of the Institute for Competitiveness in Rome, advisor of European institutions.

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