Industrial Policy for National Champions

4. Subsidizing National Champions

4 Subsidizing National Champions: An Evolutionary Perspective Cécile Aubert, Oliver Falck, and Stephan Heblich 4.1 Introduction One mission of the EU Lisbon Strategy is to make Europe “the most competitive and dynamic knowledge-based economic region in the world.” Although there are many different ways to reach this goal, the idea of an industrial policy that promotes European or national champions as the best way to compete in a globalized world has become (again) en vogue among European politicians. While the desirability of promoting champions is the object of much discussion, it is not always clear what a champion is, nor what type of champion will receive the most attention from politicians (Maincent and Navarro 2006). In a rapidly changing business environment , national champions can be up-and-coming firms engaged in creative destruction, innovative firms operating at or close to the technology frontier, or large firms that maintain employment in a region or confer prestige on the politicians who support and protect them. In this chapter we argue that these different types of champions occur at different phases of a product life cycle. According to Gort and Klepper’s (1982) knowledge-based view, the phases along a product life cycle are defined as follows. The very “early” phase is best characterized by experimentation undertaken in the quest for a dominant product variant—leading to high firm turnover. In the “intermediate” phase, some product variants dominate the growing market—leading to firm growth and firm entry but very little exit. In the “mature” phase, firms concentrate on process innovations to reduce production costs and there will be a certain amount of market entry by new firms that copy the established product and benefit from low production costs (e.g., a low-paid workforce). National firms must keep pace with the speed of process innovation, develop 64 Cécile Aubert, Oliver Falck, and Stephan Heblich new products along another life cycle, or exit the market (see also Klepper 1996, 1997). According to Aghion et al. (2009), for firms at the technology frontier, constant innovation is the only way to escape competition. However, firm failure only occurs in competitive markets. If a firm feels fairly confident that the government will protect and support it, no matter what its position in the market, the firm may not spend much time, money, or effort on innovation. As voters are uncomfortable with an economy founded on unpredictable firm selection (leading to fast but erratic growth) and prefer slow but smooth growth (Roe 2003), politicians up for reelection will prefer to subsidize firms or industries that are in danger of becoming losers in a process of creative destruction (Dewatripont and Seabright 2006). Because firms are well aware of this, their incentive to invest in research, to innovate, and to relocate their assets in more profitable activities is reduced. This well-known insight explains the diffidence of many economists toward national champion policies. We, however, argue that different knowledge externalities are generated at each stage of a product’s life cycle, and that these externalities may warrant government intervention, even in the absence of lobbying and capture, to foster investment and efficient redeployment of assets. Investment subsidies or protection from competition may be socially beneficial. Examples of costly policies by politicians concerned with reelection are also discussed. In this chapter we focus on industries where firms need to innovate and develop new products to survive. Several market imperfections may justify intervention. First, competition is unlikely to lead to efficient levels of innovation and of redeployment of assets in the presence of externalities and information leakages. We argue that such externalities are important in the industries we consider. Second, competition may not lead to efficiency in the presence of imperfect credit markets. Therefore we consider two types of interventions that may improve overall efficiency, namely subsidizing innovative firms at early stages, and protecting firms with mature products from competition. We use the assumption of a benevolent politician to compare how these two ways would impact the promotion of national champions. We consider the case where both forms of intervention raise the incentive of local firms to invest in R&D activity. This will be particularly beneficial when such investments generate positive local externalities, including, for example, tacit knowledge acquired by firms and employees and/or Subsidizing National Champions 65 processes adopted from other industries (such...