Industrial policy is the attempt by government to direct the allocation of resources into particular areas. The Obama administration is formenting industrial policy, although it is not offering a specific plan labelled "industrial policy." Problems with industrial policy include the ability of government officals to know better than the private sector what new areas are likely to be economically viable over time, allocations may be based more on political influence than economic rationality, and unintended consequences.
The auto industry provides an example. Supposedly, General Motors and Chrysler are on short leashes to reorganize in a way acceptable to the government. The President has stated that he wants to see the American auto industry become a leader in building the next generation of clean transportation. Using government funds to push GM in that direction is an example of industrial policy. Do government officials have a better idea than people who have worked in the industry for years as to what technology will ultimately prove reliable, affordable and clean?
The auto industry, along with AIG, provide illustrations of unintended consequences. General Motors and AIG have competitors, and some of these competitors are not receiving funds from the government. In particular, Ford has not asked for government money. Yet, the government is giving funds to General Motors that may enable them to reorganize in a swifter fashion than would take place under Chapter 11, and may tip the competitive balance toward GM and against Ford. Competitors of AIG have said that AIG has used some of the money received to offer better rates on some product lines, tipping the competitive balance of power in favor of AIG.
It may be that GM and AIG are "too big to fail" and for the sake of the nation as a whole, the bailouts are necessary. I am not convinced, but it may be the case. Yet, the government actions and financial support have the potential of benefitting the firms who were losing the competitive battle in the marketplace and harming firms that were operating more efficiently and competitively. Government support alters the competitive balance.