Industrial Policy through the Restriction of Capital Flows: A Test of Several Claims Made about Industrial Policy

Abstract

We examine the extent and effect of an interest rate-based industrial policy in Japan, France, Great Britain, and West Germany while using the United States as a control case. We argue that some governments have undertaken industrial policies that achieve a belowcompetitive interest rate, thereby allowing the redirection of financial flows to firms in the form of cheaper capital. Zysman, Shonfield, and others believe these restrictions on interest rates cause additional firm investment, change the time horizon of managers, and transfer wealth from domestic savers to domestic firms. We first examine the role of industrial policy by assessing the relationship between domestic interest rates and Eurocurrency rates. We argue that the degree of difference between these rates is an indication of the extent of one type of industrial policy. We then evaluate the relative influences of domestic and external interest rates on stock prices as a way of measuring the consequences of these industrial policies. If the policy were completely effective (i.e., insulating the relevant interest rate from market forces), only the domestic interest rate would influence stock prices. We assess the conditions under which states demonstrate sufficient strength to undertake policies to insulate domestic markets. We find that only France under the Socialists succeeded in positively affecting economic activity through this type of industrial policy, and that Britain prior to Thatcher's election demonstrated ineffective policies. Some evidence also indicates that Japan's industrial policies were less effective than previously believed. No evidence of such policies was found for West Germany under either the Socialists or the CSU/CDU alliance. We tested for partisan political changes in government policies, and except in Great Britain, found none.