Industrial policy and subsidies are nothing new and can be useful. But shutting off from the world will have consequences.
Beginning with the Trump administration, and accelerating under the Biden administration, U.S. trade and industrial policy has prioritized relocating manufacturing production back to the United States. For all their differences, both administrations disregarded other countries in this pursuit. Both also attacked international trade and investment as harmful to U.S. economic and national security, even though the rules for that very system were established by the United States and serve its interests. Along with members of Congress from both parties, the Biden administration has sought to take away production from others in a zero-sum way—explicitly from China and a bit more courteously from others.
This policy approach, while having considerable popular appeal at home, is based on four profound analytic fallacies: that self-dealing is smart; that self-sufficiency is attainable; that more subsidies are better; and that local production is what matters. Each of these assumptions is contradicted by more than two centuries of well-researched history of foreign economic policies and their effects. Neither the real but exaggerated threat from China nor the seeming differences of today’s technology from past innovations change underlying realities.
Industrial policy—government subsidies and protections to promote domestic capacity in a favorite sector—is nothing new in U.S. or global economic history, and it can be useful. The Biden administration’s renewed push for public investment in infrastructure, research, and innovation is welcome, if oversold in its direct employment benefits. Targeted export and investment controls on China, Russia, and other military rivals on a limited number of well-defined high-tech goods could also be sustainable and worth the economic cost. But the protection and promotion of U.S.-located manufacturing against foreign competition is not only unnecessary for industrial policy’s success—it will defeat the worthy purpose of it.
There is no question that many Chinese policies, including economic ones, are aggressive. They pose a threat to China’s immediate neighbors, to U.S. national security, and more broadly to human rights and democratic sovereignty. But the extent to which China poses a direct threat to U.S. economic security is overblown. This is especially true since commerce with China yields significant benefits, Beijing is no longer massively undervaluing its currency against the dollar, and many of its supposedly self-serving, even cheating, tactics in trade have backfired. For example, subsidizing steel until it reached vast overcapacity has been a sinkhole rather than a success for China, contributing to environmental degradation and helping to ensure an uncompetitive workforce.
Nonetheless, those involved in U.S. economic policymaking face two difficult questions: First, what parts of the economic relationship are fueling Chinese military aggressiveness, either in capacity or intent? And second, what economic as opposed to diplomatic or military tools would be effective in stymieing Chinese threats to U.S. security? After all, further economic decoupling from China will have costs: not just to consumers and businesses but to U.S. military and intelligence capabilities. These include losing access to Chinese technologies that the U.S. military can benefit from and forgoing intelligence derived from commercial engagement with Chinese companies. Additionally, Washington would have meaningfully fewer resources to spend on defense and information-gathering because everything the United States acquired abroad would be more expensive, including capital to finance part of government debt.
A unilateral U.S. withdrawal from commerce with China would be partially offset by other economies taking up market share where the United States no longer operated. If anything, it would increase the arbitrage opportunities for other countries and for companies headquartered elsewhere to trade and invest where the United States ceased to do so.
What will not address these threats—and what, in fact, will backfire—are U.S. attempts to impose arbitrary export and investment restrictions on China that extend to other countries. In order for such restrictions to succeed, the United States would have to become a commercial police state on an unprecedented scale. The United States would also have to monitor and prevent its own headquartered companies from moving activities abroad. Washington has done this, on a limited scale, on specific technology transfers. But scale matters, and current proposals would be an order of magnitude more ambitious and thus infeasible. Besides, U.S. industrial policy should encourage the widespread adoption of the best technologies at home and abroad rather than favoring localized domestic production, which only limits the spread of technology.
Aggressive behavior from Beijing is instead best confronted by diplomacy and defense capabilities. Washington may feel frustrated with the lack of quick wins here, but that is no reason to take that frustration out on the rest of the world—let alone on private Chinese companies that happen to have had commercial success. In fact, doing so will make U.S. security worse by hindering the technological progress necessary for resilience and by eroding the United States’ influence on third countries.
Compare this approach to what was for a long time the status quo: the United States as creator and enforcer of international economic rules, not visibly and directly picking who was in or out in a given industry. The United States benefited from acting within the system to constrain countries’ specific behaviors rather than publicly judging their general nature. It could even occasionally flout the rules, or tweak them in its favor, if it didn’t overdo it. Most of all, though, leading a rules-based system allowed maximum economic traction while minimizing the need for direct conflict.
An economic and trade strategy that calls out individual countries, complete with tit-for-tat retaliation for perceived or actual slights, throws this all away. Instead, the United States becomes just another player in the game, with no justification for its self-dealing and no reason to stay on its good side beyond one-off transactions. That transactional view, in turn, defeats the goal of reordering the economic system, whether to limit China’s military power or speed up adoption of green technologies.
Additionally, if the United States and Europe agree to discriminatory manufacturing subsidies, and only China can afford to compete, it tells the rest of the world that their aspirations for development do not matter: Only those in the lead now will be allowed to scale the heights of technological production. This would mean that countries in the developing world would have to go cap in hand, government to government, to get access to one nation-state’s products—let alone be a part of the production process. The ability of individual companies in developing economies to earn investment on merit would be sharply diminished. That would disincentivize growth and breed justified resentment.
In big-league sports, the best job is to be league commissioner. As commissioner, you make money whichever team wins or loses on a given day, you are welcome at every stadium (even if occasionally booed), and you can ultimately decide the big questions of how the game is played and who is allowed to own a team. If you instead become identified with a single team, sometimes you win, sometimes you lose, but most importantly, others have an interest in your losing. You might even get repeatedly punished for cheating, instead of being the one to decide who is cheating. And when it comes to another issue in the news—supply chains—the tendency to join a side rather than oversee it all is equally shortsighted.
The idea of “Buy American” has broad populist appeal. It connotes an economy that is self- sufficient, producing all it needs, and “putting American workers first.” Yet detailed research has repeatedly shown that policies aimed at maximizing domestic manufacturing employment rather than the development and adoption of new technologies are not only doomed to fail but crowd out the very industrial and trade policies that contribute the most to innovation, national security, and decarbonization.
Recent supply problems contributed to the Biden and Trump administrations’ proposals to invest in local production. But as scary as a shortage of semiconductors has been, it is truly the exception that proves the rule. In reality, market economies adapt quickly to shortages; dominant suppliers almost never boycott selling to customers. Also true is that shortfalls in supply are much better addressed through trade and, in the case of some technologies, the stockpiling of strategic reserves.
Take the European Union’s response to stoppages in oil and gas supplies after Russia’s invasion of Ukraine. Eurozone economies adapted to higher and more volatile energy prices far more rapidly than most expected. Prices even dropped after European economies stopped demanding so much supply. The same has been true at every juncture when there has been an interruption in supply or when energy exports have been withheld; in 1973, after a Saudi-led oil embargo, Western economies shifted production and consumption patterns within a couple of years.
Yes, a supplier of a critical commodity with malevolent intent can cause pain via temporary shortages, but an effective response is to stockpile strategic reserves and turn to trade with other places.
Meanwhile, Russia did not get anything terribly useful in diplomatic terms when it tried to weaponize Europe’s dependence on its oil and gas. When Russian President Vladimir Putin cut off gas from the Nord Stream 1 pipeline in mid-2022, he induced Germany and other European economies to reduce their dependence on Russia while strengthening Europe’s support for Ukraine. His dominant supply position did not even prevent the EU from encouraging Ukraine to turn its way in recent years. And despite Putin’s threats to cut off global supplies, Russia has up to the present day continued to keep oil and gas exports flowing to other buyers.
In other words: In an actual war situation, with a most malevolent supplier making seemingly credible threats, Europe has not been deterred or even swayed. This shows that market economies’ resilience is much greater, and the ability of suppliers to extract concessions much less, than the scaremongering used to justify extreme U.S. industrial policy would suggest.
Investing in productive capacity tied to jobs in specific localities is misguided for two reasons. First, it does not create new jobs; it merely shifts jobs from one place to another. To create jobs in one place, a handpicked publicly subsidized investment has to draw the workers with the relevant skills from other U.S. employers, unless those workers come via immigration increases or are sitting idle and willing to move. More immigration would certainly be desirable for this and a host of other reasons, but it is extremely unlikely in today’s political climate. As for idle workers with the right skills, they don’t really exist. Currently, the U.S. industrial economy has a vast excess of job vacancies relative to the number of available workers, with notable shortages in the kinds of employees needed for the production of semiconductor chips and their components.
Furthermore, Buy American policies actually cost jobs. When the United States imposes Buy American requirements on government procurement, or restrictive “rules of origin” or local content requirements on imports, these requirements have three effects. First, they simply raise the costs of any government purchases undertaken, thereby reducing the amount of bang U.S. taxpayers get for their investment buck. Second, they cost U.S. sales in foreign markets. And third, they erode the competitiveness of U.S. goods by making exports too expensive. As is becoming apparent with the high, restrictive domestic content requirements of the 2020 United States-Mexico-Canada Agreement, there are ever fewer cars produced for export in North America. Meanwhile, there is more investment by U.S.-headquartered auto companies in China to reach that market. But what of the race for subsidies for green tech production? As desirable as it is to have the United States move forward on green tech, starting a subsidies contest with the EU is misguided, too.
An argument in favor of green subsidies is that all economies need to make more rapid progress on the energy transition away from carbon, so more investment—however achieved—is better. Decarbonization is an important goal, but history shows that rather than converging on best practices, or at least putting useful competitive pressure on domestic industries, subsidy races lead to a perpetuation of corruption. This, in turn, stifles innovation.
A classic example is the long-running conflict between Airbus and Boeing. Large airframe manufacturing has repeatedly been deemed a strategic industry by both the EU and the United States. But what has been the outcome of these two giant economies subsidizing their respective champions?
For one thing, there has been limited innovation in passenger aircraft and almost none in energy usage or changing transport paradigms. Instead, Airbus commissioned a plane that was too big for the market—the A380—and we have seen little or no investment in changing the underlying high-emissions jet fuel-based model (though some fuel efficiency improvements have been made). As with other large incumbents, let alone ones with government-protected market share, subsidies created an incentive to maximize current production, not to innovate disruptively.
More generally, with Airbus and Boeing deemed too strategically important to fail by the EU and U.S. governments, they are inadequately supervised. The companies exploit this fact, not just in cost overruns on defense and public projects but in substandard production. Like the too-big-to-fail banks in the run-up to the global financial crisis, they put both the underlying system and many of their customers at risk of devastation.
Why would semiconductor or other subsidized manufacturers, which would also be too big to fail, respond differently? These are industries with large upfront capital investment costs and multiyear production planning, allowing them to play on government dependence to prevent entry of new competitors. Anyone rightly concerned with monopoly power from industrial concentration should recognize that this threat applies especially to companies insulated from both domestic and international competition.
Setting aside the risks of monopoly power, undersupervision, and corruption, there is another reason that national subsidies for strategic industries do more harm than good: They add a political tenor to the allocation of supply chains. While it may feel consistent with values to have Washington encourage friendshoring, the result is supply chains that are designed to pursue neither efficiency nor resilience; instead, they are designed to forge political and security relationships. This has other, unintended consequences: Supply chains become more rather than less fragile, as they lack redundancy and are subject to changing political relationships. Plus, trade disputes escalate, slowing commerce as well as blocking other (useful) forms of cooperation among nations.
The Airbus-Boeing subsidies war is again an example. It has prompted recurrent trade and legal disputes that have directly impeded EU-U.S. cooperation on a range of adjacent issues. That’s even as supply chains in aircraft manufacturing have become highly fragile, as evident in production problems long before the COVID-19 pandemic and China raised concerns about such vulnerabilities.
Another compelling example of the damage done by countries discriminating on a national basis is food subsidies. For all the current talk about resilience and local supply chains, the fact is that agriculture has been the most subsidized industry in the advanced economies for decades. Just as with Airbus and Boeing, the results have been far from ideal.
Where there has been innovation in agriculture, national barriers have prevented its uptake. Genetically modified organisms, or GMOs, offer great promise for health and nutrition enhancement globally. The EU’s imposition of standards against them blocks adoption in large parts of the world. Some of that is due to genuine concern, but a lot of it is European agricultural interests using vague fears as an excuse to block competition from U.S. exports. As a result, if developing countries import GMOs, they can be blocked from exporting food to the EU. Countries in the developing world are forced to choose to accept viable crops and food aid from either the United States or the EU—but they cannot benefit from both.
If anything, the harms of the dueling subsidies dynamic would be particularly bad for accelerating a green energy transition. To get new energy technologies to displace older ones, they need to be adopted on a large scale—mass electric vehicle charging or replacing coal power generation. Differences in energy performance among technologies will matter materially for our outcomes in adapting to climate change; when a given technological standard is set and in wide use, the impact of lagging efficiencies compounds.
There also is no reason to think that domestically favored producers in the EU or United States, or for that matter China, would have a monopoly on good ideas for decarbonization technology. As with vaccines, global competition and innovation are needed. If you shut yourself off, insisting on local production of indigenous technology, as China and Russia did in developing their COVID-19 vaccines, there are vast consequences. In a subsidies duel, there is every reason to think that national-champion companies and their captured governments will use differing standards to set up barriers to entry for foreign-produced products. Even more than food or airplanes or vaccines, having energy grids, batteries, and innovative technology for transportation or heating, ventilating, and air conditioning separated into autarkic networks will be counterproductive for resilience and adaptation.
The political dynamic of third countries—including large carbon emitters such as Brazil, India, Indonesia, and Mexico, if not China—being forced to choose between European and U.S. technology for their energy systems will directly impede decarbonization. Maybe these larger emerging economies will be able to set off a bidding war among trans-Atlantic producers for the contracts, but that will not lead to the best technology winning or to the fastest adoption of it. That’s why the subsidies competition between the United States and the EU that the Biden administration is ratcheting up is in reality a dangerous setback for decarbonization.
The single best thing the United States can do to advance its national security and climate change goals is support the widespread adoption of common technologies that reduce vulnerabilities to supply conditions, to Chinese intelligence incursions, and to dependence on carbon-based energy. This is best done through extensive public investment in research and infrastructure as well as by encouraging global competition and the spread of technologies in relevant industries such as batteries, cyberdefense, and vaccine manufacturing.
It is important here to distinguish technology production from technology adoption. Public investment in producing technology is sometimes productive and sometimes wasteful, but it is nothing new for the United States. For all the hype circulating around the Inflation Reduction Act and the CHIPS and Science Act, as well as other measures on their way, these policies do not represent a major creative break with neoliberal constraints. These measures will not accelerate U.S. economic growth or job creation beyond an initial spending bump, as with any fiscal expansion. They will not revolutionize U.S. competitiveness, and their implementation will most likely enrich small pockets of protected businesses rather than making a dent in reducing income inequality. As an economic program, these policies may be helpful or may not, but they are far from transformative.
What these programs do not do is accelerate the adoption of technology. It is much less the production than the adoption of technology that ensures national security and that can slow climate change. To see adoption in effect, rather than just production, we need only look to the 1990s. U.S. productivity (and defense capabilities) surged during that decade because U.S. companies (and the U.S. military) adopted information technology across the economy. Shippers were tracked, inventories were monitored and restocked, repetitive tasks were automated, and job descriptions changed mostly for the better.
That leap in productivity came about not because the United States produced computers or chips, which got repeatedly cheaper, moved down the value chain, and represented an ever-smaller part of its economy. The leap happened because the United States transformed its business practices and created new offerings—in services as well as manufacturing—to make full use of the new technology. Simultaneously, Europe, Japan, and China all failed to adopt and adapt as much as the United States did, and they fell behind. Notably, they fell behind despite their own protectionist industrial policies on behalf of local information technology producers —which the Biden-Trump worldview says were unfair advantages and that the United States should now emulate. They needed to import new technologies and best practices from abroad to close the productivity gap, but the Chinese, German, French, and Japanese obsessions with their own manufacturing hindered that adaptation.
This example reflects a general rule of economic development. If the source of technological power were producing a given weapon or manufacturing system, not its application and use, everyone could reverse-engineer their way to technological near-equality. There has been no shortage of industrial espionage and intellectual property theft by Chinese, North Korean, and Russian entities over the last two-plus decades. The evidence is that the vast extent of IP theft claimed by China hawks has occurred while China’s growth rate has rapidly slowed down.
Developing economies from Brazil to India have also demanded licensing of advanced technology and acquired it only with an eye to creating their own industries. That has not meaningfully closed the gap with the United States on per capita income or technological sophistication at the frontier. Here, then, is the central fact: Growth comes from economywide adaptation of general-use technologies and not the production of particular products.
Compounding matters is that attempting to increase domestic production of technologies when you do not already have a leading industry generally backfires, as displayed by China recently. China’s major effort to create indigenous semiconductor production, undertaken even before U.S. export restrictions, left it unable to produce the cutting-edge chips. By China’s own admission, its chips industrial policy project also wasted billions of dollars, diverted engineers from other activities by shifting rather than creating jobs, and resulted in corruption by managers and officials. China failed to catch up, let alone create widespread, innovative use of the latest chips in the economy.
Even on the military side, where advantages in specific weapon capacities can be critical, the persistent failures of the Russian military in Ukraine came in large part from the failure of preferred local producers to deliver. There has been no lack of effort from Russian intelligence to gather the technological secrets of the West, nor any scruples holding Russian companies back from reverse-engineering on a vast scale with government support. Getting your hands on a particular weapon is far less important than an ability to use it effectively—and a willingness to make such systems available across society.
Supply chain resilience, sustainable income gains for American workers, defense against Chinese aggression, and accelerating greener energy are all worthy goals and worth paying for. Disregarding the global realities of technology and trade in pursuit of those goals, however, will do more harm than good for U.S. economic and national security. At issue is the longer-term damage to Washington’s own interests from pursuing a zero-sum approach to manufacturing production at the expense of the rest of the world. Such an approach, largely shared by the Biden and Trump administrations, will certainly harm China (as well as the United States), but it will still be ineffective at reducing the threat from there.
At its core, a successful U.S. industrial policy is one that promotes the widespread diffusion and adoption of the best technologies, even if that means the United States purchasing them from production located abroad. Innovation and technical progress are accelerated by having common standards at global scale, not by politically captured industries with barriers to entry. This approach is especially necessary for decarbonization but also to increase supply chain resilience and the ability of other countries to stand up to Chinese threats.
The best path forward for the U.S. government is to simply correct the discriminatory aspects of recent legislation—including the CHIPS Act, the Inflation Reduction Act, and the Infrastructure Investment and Jobs Act—directly. Reality has already forced the Biden administration to do this in an ad hoc way: To prevent a mass counter-attack by European and Asian allies, the U.S. Treasury inserted a loophole for foreign-manufactured electric vehicles to get buyers the same tax credit. In key industries where a U.S. producer does not exist, such as in batteries and other electric vehicle clean tech, it is forcing them into joint ventures with U.S. firms. This is what China forced foreign firms to do when it wanted to “acquire” leading technologies. China’s move led to the mutual distrust between the two countries today, but now the United States is doing the same to its allies.
Instead, Washington should post a narrow list of militarily important technologies that should not be exported to China and that the United States should not be solely dependent on Chinese production for. Let the rest develop organically. Similarly, it’s better to coordinate, not compete, with the EU, Japan, South Korea, and Taiwan on public investment in high tech. This would remove commercial conflict and reduce barriers to the spread and adoption of the best technologies while still subsidizing progress in critical areas. The United States should go back to its commissioner’s role in the global economy—allowing others to win or lose any specific game or even season but ultimately shaping who plays under what conditions. That, rather than the current shortsighted self-dealing, would be an industrial policy that would work.
Source: Foreign Policy
