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Industrial Policy Coming Into Vogue After China Cleans US Clock by Using It

Summary:
For many years, this humble blog has described how the US, contrary to our own popular mythology, does industrial policy by giving certain sectors tax breaks, cheap funding, government backstops, and/or direct government spending. Those industries include heath care, real estate, higher education, banking, and arms making. In other words, like Moliere’s Bourgeois Gentilhomme, who was surprised and pleased to learn that he was speaking prose, the US has long engaged in industrial policy, but by default, to serve special and powerful rather than national interests. But it appears that the success of China in orchestrating its economy has become so undeniable that folks inside the Beltway have gone from trying to counter the impact of Chinese intervention to copying from their playbook.

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For many years, this humble blog has described how the US, contrary to our own popular mythology, does industrial policy by giving certain sectors tax breaks, cheap funding, government backstops, and/or direct government spending. Those industries include heath care, real estate, higher education, banking, and arms making. In other words, like Moliere’s Bourgeois Gentilhomme, who was surprised and pleased to learn that he was speaking prose, the US has long engaged in industrial policy, but by default, to serve special and powerful rather than national interests.

But it appears that the success of China in orchestrating its economy has become so undeniable that folks inside the Beltway have gone from trying to counter the impact of Chinese intervention to copying from their playbook. We’ll turn soon to the Wall Street Journal story describing this change in heart.

It seems peculiar that it’s taken this long for the US to realize the error of its ways. After all, there was even more moaning about the rise of Japan in the 1980s, and its use of industrial policy was widely acknowledged as central to its success. But the 1980s were also peak Reagan/Thatcher, so pushing for more muscular government was totally at odds with the fads of the day.1

So it’s long been unseemly to acknowledge that government plays a huge role in the economy and consider that it might make sense to be deliberate about it. And it’s not as if we still aren’t to some degree: Mariana Mazzucato in her landmark book, The Entrepreneurial State, described how the government and major tech schools like MIT, Stanford, and CalTech, have flexible, freewheeling, and productive relations with government. But American greediness has also gotten in the way. For instance, Mazzucato described how the government sponsored the creation of the LCD industry and wanted the US to become an important manufactured. But Silicon Valley venture capitalists didn’t see making stuff as high return enough, so we ceded production to Asia.

We have separately regularly pointed out that it’s crazy for the US, which has the resources to enable it to operate as a near autarky, to have become so dependent upon foreigners for critical materials and components, starting with chips. Reading between the lines of this Wall Street Journal account, it is the chip shortage that’s led to a change in heart about picking industrial winners. From the Journal:

The U.S. and its allies have long pressed China to stop helping favored industries with subsidies, government preferences and other interventions.

Now they are beginning to copy it. Last month, the U.S. Senate voted for direct industry subsidies with little precedent: $52 billion for new semiconductor fabrication plants, called “fabs.”…

Chip-manufacturing subsidies are the most prominent of a range of interventions Western governments are rushing out to promote industries they deem strategic, from electric-car batteries to pharmaceuticals. Such interventions have increased sharply in both the U.S. and Europe in the past decade, according to Global Trade Alert, a trade-monitoring group.

Collectively, this represents an embrace of “industrial policy,” the idea that governments should direct resources to industries critical to the national interest rather than leaving things to the market.

Industrial policy was once commonplace among market-based democracies…They pulled back over recent decades….

China, though, never retreated. Even after it introduced market reforms in 1979 and accelerated them after 1992, the state continued to guide economic development through ownership of enterprises and control over credit, government purchases, tax preferences, land and foreign investment. Since 2006 the ruling Communist Party has put priority on catching up to the West technologically.

Previously called “Made in China 2025,” this endeavor was renamed “dual circulation” last year. In a speech, President Xi Jinping said the goal was to eliminate China’s dependence on other countries while increasing their dependence on China. It could then threaten to cut off foreign customers to deter aggression, he said.

Now, of course, one problem with the West emulating this approach is that in the Anglosphere, the caliber of the bureaucracies has plunged. Going into finance or tech is where the big bucks and glamour lie. There’s no counterweight of prestige to help government agencies with recruiting, outside the revolving door patronage appointments. And to compound this situation, most officials have internalized the idea that governments should defer to commerce. For instance, C-SPAN is full of cringe-making displays of Congresscritters fawning over CEOs.

Another problem is that conducting industrial policy requires long-term priorities and funding of initiatives. But there’s no reason to think the Feds would be any better at “long-term” than our famously short-term private sector. It’s not hard to see a new Administration shelving a lot of pet projects of its predecessor, just to make a statement.

The Journal continues:

In U.S. there has long been broad support for government funding of basic research and development. One result is that the U.S. still leads in inventing and designing new technology, even though the manufacture of the resulting products moved abroad, mostly to East Asia…

Advocates of industrial policy in Congress and the White House are no longer satisfied simply promoting innovation; they want the resulting products to be made in the U.S. They have multiple goals: to secure U.S. supply, create jobs and ensure that the resulting intellectual property stays in the U.S. rather than being transferred to Chinese competitors via outsourcing.

Last month, the White House proposed a breadth of tools to boost domestic production in four sectors deemed vital to the supply chain: semiconductors, batteries, specialized minerals and pharmaceutical ingredients.

It proposed using several existing federal loan, tax-credit and R&D programs to support electric-vehicle battery manufacturing. To reduce dependence on foreign supplies of neodymium magnets, important components of motors and other devices, it suggested imposing tariffs under the same 1962 national-security law that former President Donald Trump used to impose tariffs on imported steel and aluminum.

The administration also announced plans for a public-private consortium to revive domestic production of 50 to 100 critical drugs, as well as plans for a domestic lithium-battery supply chain.

So the US is getting religion, albeit late in the game. For instance, pharmaceutical inputs are a big area of vulnerability. From a 2018 post:

A recent book, China RX: Exposing the Risks of America’s Dependence on China for Medicine by Rosemary Gibson and Janardan Prasad Singh, appears not to have gotten the attention it warrants..

The big message of Gibon’s and Singh’s book is that the US relies on China for the production of active ingredients in drugs and in many cases, of the medications themselves, to the degree that we would have a public health crisis if supplies were interrupted. As Gibson said on C-SPAN:

Many people that we spoke to, both former government officials and some in industry said that if China shut the door on exports, within months, pharmacy shelves in the United States to be empty, and hospitals would cease to function.

And don’t assume generics king India would step into the breach. India gets many of the active ingredients for its pharmaceuticals from China. Gibson forecasts that China will overtake India in generics manufacture within a decade.

As Gibson explains, the US no longer makes its own penicillin, in part because China dumped penicillin in 2004, driving the last US plant out of business.

The medications where the US relies on China include heparin, a blood thinner that among other things is used for IV drips. No heparin, no IV treatments. Due to the difficulty in tracing the source of drug company ingredients, the authors could make only case by case investigations, but they China production to be critical for treatments for Alzheimer’s HIV, depression, schizophrenia, cancer, epilepsy, and high blood pressure.

But the “provide subsidies and they will come” approach is naive. First, the record of tax credits and other gimmies is that they overwhelmingly activities that would have happened anyhow. Second, the officialdom seems to miss that building stuff doesn’t happen in a vacuum. It often requires skilled lower level workers, supervisors, and factory managers. Even with a push to train more high school students to become future tech manufacturing workers….where do we get the critical cadre of operation managers?

Another issue is cost. In an ideal world, the plants would be in decent proximity to customers so they could collaborate closely. Remember “clusters”? The price of real estate in Silicon Valley is an impediment, and I assume it’s not much better near MIT or Austin or Seattle.

So while industrial policy is long overdue, it’s been so long since the US has been any good at it that I’m not sure anyone inside the Beltway has a good idea about how to put one foot in front of the other.

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1 The reason for Japan’s bubble and bust had just about nothing to do with its industrial policy. Banks were supposed to be only minimally profitable and support industry. The returns on assets of Japan’s banks were accordingly stunningly low compared to big banks in the rest of the world. But the US (remember Japan was and still largely is a military protectorate of the US) forced rapid deregulation upon Japanese banks, which focused on retail and simple corporate lending. It was like telling a drayage company that it was really in the transportation business and giving it a 747 to fly.

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