And Policy”12 , the empirical record on such industrial policy is very low.
While the subsidized sectors have in most cases expanded as a result of the subsidies, that is not enough to demonstrate that the policy was successful, as again the production factors used have an opportunity cost in other industries. And as was pointed out, subsidized industries generally had a lower rate of return than other industries, indicating that resources were in fact used less efficiently. In most cases, labor compensation wasn't higher either. And even in the cases that it was, it doesn’t prove that labor received a higher compensation as the workers in those industries were better educated and more productive in the first place.
One argument for such targeted subsidies is that even though the direct return of investments may be lower, the subsidies will create positive so-called externalities in the form of so-called technological spill-over. There is a limited degree of truth in that argument, but it overlooks how all investments and indeed all productive activities generate positive externalities. New investments of all kind generate extra productive capacity, which generates increased purchasing power that benefits not only the workers and capital owners in that particular factory, but also suppliers and customers of the company and producers of the goods and services demanded by the workers and capital owners and so on. The same thing goes for increases in labor supply, which also helps boost production, which create similar positive benefits for the rest of society.
Another argument frequently advanced especially in these days is that if certain companies are allowed to fail in the sense of going bankrupt13 then this will have such negative repercussions for the rest of society that saving them is necessary to avoid a really disastrous slump and mass unemployment. This argument is used for bailouts both of financial companies and automobile makers.
12 Krugman-Obstfeld (1996) pages 285-295. I here assume that bankruptcy means liquidation. It might however have the less dramatic meaning of ownership simply being transferred from shareholders to the bankruptcy estate, with operations continuing, as has been the case for many American airlines. Since the effects of that is much less dramatic, the case for bailouts is even weaker. 13