The intellectuals in the Republican Party and conservative think tanks have had a hard time over the last couple of years. Traditionally a bastion of free traders, they have seen their party taken over by a bunch of protectionists and mercantilists with Donald Trump as their figurehead. As every observer of US politics knows this has led to a split in the Republican Party intelligentsia: some stayed true to their intellectual values and became “never Trumpers” while other tried to accommodate themselves and the Republican Party with Trump’s protectionist trade policies.
The latter group argued that Trump was right to criticize China’s unfair economic policies that benefitted from protectionist measures in its home market and intellectual property (IP) theft of Western technologies. Some joked that China was in the C2C business: copy to China.
I agree that China uses unfair means of economic competition and that we need to get a handle on these measures, in particular IP theft. However, what people in the US conveniently forget is that almost every major economy that moved up from emerging to developed economy did so through the means of some form of mercantilist policy and often with the help of IP theft. If you read Ron Chernow’s excellent biography of Alexander Hamilton you will learn that he encouraged skilled British workers to leave the country and settle in the US where their “inventions” would be patented to guarantee them a quasi-monopoly on the technology. This was essentially a call for IP theft since skilled workers were banned from emigrating from the UK, let alone stealing IP. Nevertheless, in 1791, George Parkinson was awarded a patent for a textile spinning machine, which was effectively a copy of the spinning jenny. Similarly, in 1789, Samuel Slater emigrated to the US where he set up the first textile factory in the US by copying the weaving and spinning machines he had used in the UK.
But I digress.
So, while conservative think tanks agree with the goals of Donald Trump they disagree with the means he uses to achieve his goals. Tariffs are a highly ineffective and destructive tool to even the playing field between the US and China. But where there is a will there is a way. If you ask enough economists to come up with the desired solution to a problem, you will find one. And it seems as if conservative leaning economists are in the process of pushing one such solution: industrial policy.
Industrial policy measures are measures enacted by a country to protect its economy or parts of it against unfair international competition. Tariffs, import bans and the like are the crudest of these measures, but industrial policy also took on the form of “voluntary” import quotas for Japanese cars to the US in the 1980s under Ronald Reagan. Similarly, many emerging economies use industrial policy measures to protect a nascent industry from being crushed by bigger international competitors. South Korea, Japan and Germany all have at some point or another protected parts of their manufacturing, mining or energy industry from international competition. Some developing countries protect their nascent financial services industry from unwanted international competition as well.
The idea is that once the protected industry has become big enough to withstand international competition, the industrial policy measures are revoked and free trade can reign to provide the most efficient use of resources.
In practice, this kind of industrial policy often creates inefficient industries that can only survive due to government subsidies. The worst-case scenario happens when industrial policies are used to protect an inefficient, dying industry because the government is afraid of the potential job losses if they let the uncompetitive industry go under. The German government spent billions to subsidize the German coal industry and avoid its inevitable decline. Americans who argue that the local steel or coal industry needs similar protection to avoid extinction should read up on the German example, which provides a stark warning of the negative effects of bad industrial policy. In fact, in Germany, the strong growth in renewable energy was a boon for the economy that was delayed for years, if not decades, due to the unwillingness of the government to let the coal industry go bust.
But industrial policy can also have beneficial effects for an economy. It can be used in developed countries to protect a nascent technology from being undercut by old technologies for as long as production costs of the new technology is higher than the costs of older technologies. Renewable energy was, and in many countries still is, benefitting from government subsidies to make it competitive with fossil fuels. Now that energy production from renewable energy sources is getting competitive with fossil fuels, these subsidies have been abolished in some countries and are phased out in others to let market forces take over. In this case, industrial policy acted like an incubator for new technologies.
On 14 July, the National Conservatism Conference hosted a debate between Oren Cass and Richard Reinsch about the potential use of industrial policy in the US to protect the manufacturing sector. Their opening statements are available here and here. What I find interesting is that conservative intellectuals now argue that there are market failures that need to be corrected through the help of industrial policy. What an irony given that many conservative intellectuals used to argue that free markets can solve any problem and that such things as market failures either don’t exist or are irrelevant.
The fact is that free markets are the best solution to most problems, but there are circumstances where markets fail. Most commonly, these market failures happen when there are externalities that are not priced in the market and thus markets have no way of adjusting economic activity to minimize the impact of negative externalities. The classic example going back to Alfred Coase is pollution. If you run a factory and spill chemicals into the local river, you have no incentive to avoid such spills or clean the river as long as there is no price to pay. Only once there is a price to pollution will economic activity become efficient.
And this is where the problem starts. The decline of the American coal, steel and manufacturing business is not due to negative externalities or market failure. It is due to the uncompetitive products the US produces. Labour costs in the US are higher than in many developed countries and even where US products are competitive on a cost basis, they tend to be of such low quality that nobody wants to buy them. When Donald Trump complained that Americans don’t buy American cars but German cars instead, the reaction of the German economy secretary Sigmar Gabriel was a shrug of the shoulders and the immortal words: “If the Americans would build better cars, people would buy them.”
In my view, the American coal, steel and manufacturing industry has to either become more competitive by building better products or it should be let go. It is hard for the individuals who lose their jobs, but these issues could be tackled with retraining programs and n improved social safety net. In the long run, this would be much cheaper than protecting their existing jobs, as the experience of Germany has shown.
But there is still one area where industrial policies may make sense in the US: IP theft. Let’s face it, IP theft by China is hard to stop and even if you can catch the thieves, it is hard to sanction the world’s second largest economy without hurting your own economy, which is what currently happens with the US-China trade war. So, instead of trying to prevent IP theft, I would suggest industrial policy measures that encourage research and development activities domestically in order to always be one step ahead of your international competition. Let them steal our technology. We have the next generation ready to deploy, so who cares about the old stuff…
This can be done with clever industrial policy. For example, the government could subsidize both academic and private sector applied research and development (R&D), reduce taxes on profits generated from new technologies developed domestically, reduce regulatory burdens for the approval of new technologies, etc. As I have said before, we are clearly not spending enough on R&D at the moment and this lack of R&D investment contributes to the lower productivity growth and economic growth observed in the West since the financial crisis. Smart industrial policy could thus lead to stronger growth create more jobs and higher profits for businesses. All we need now is smart politicians to implement these policies…