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Friday, Dec 9, 2022

The Rebirth of Industrial Policy in the United States

As Chinese economy rises, U.S. embraces direct support of industries

The U.S. Innovation and Competition Act of 2021, a $250 billion package passed in June to facilitate the research and development of science and technology, represents a sea change in U.S. economic strategy and a return of the government use of industrial policy.
But the embrace of industrial policy to solve economic and strategic problems carries considerable risks.

Government-inspired industrial policy has had a mix of modest success and significant failures around the globe over the decades. Sematech, the government-financed semiconductor research consortium, remains a rare success in American industrial policy. Japan, by contrast, was never able to set the global standard in the consumer electronics market in the 1990s despite considerable government support.

Now we are on the cusp of another era of government-driven policies that involve billions of taxpayer dollars taking on economic risks.

The legislation was ostensibly passed to counter China’s economic dominance and its emerging geopolitical influence. A bipartisan group of 68 senators voted to allow the government to make economic decisions, overriding the hands-off approach that has been sacrosanct for proponents of free market enterprise.

The $52 billion put forward in the legislation to foster a domestic microchip supply chain again puts the government in the position of trying to pick winners in the manufacturing economy.

The U.S. is now willing to commit billions of dollars toward building a supply chain that would support primarily the automotive sector and, to a certain extent, gaming and consumer electronics.

Those funds, though, do not carry an explicit guarantee that the supply chain will set the standard of the next generation of technology. Billions of dollars could be lost.

Industrial policy can be defined as government interference in the free market. It can be indirect via agriculture subsidies, tax policy, procurement practices, trade restrictions and currency manipulation, all of which have domestic beneficiaries. Or it can be direct by providing capital.

The last time the U.S. government considered becoming involved in making economic decisions (and when not in the midst of a national emergency), was in the 1980s, at the height of Japan’s emergence on the world stage.

The U.S. government ultimately refrained from heavy intervention into the economy, while Japan eventually ceded leadership in consumer electronics and then missed the digital revolution that soon followed.

So when the Senate voted to shift taxpayer resources to the development of the semiconductor industry, the conversation definitely shifted.

The legislation shows that the U.S. has gone from leaning toward a pure free market framework to subsidizing a domestic industry—but only when the other party is a national security threat with the ability to shut down the supply of intermediate and final goods.

Both President Biden and top Republican policymakers have asserted that the purpose of the legislation is to counter China’s growing influence in several key areas of technology such as artificial intelligence and quantum computing, with special interest given to semiconductor production.

The development of competitive semiconductor factories, called foundries, often costs tens of billions of dollars, forming a significant barrier to entry. For this reason, the industry has consolidated, with Taiwan’s TSMC emerging as the clear leader. In effect, the world relies on TSMC semiconductors, and any disruption to TSMC’s production or supply chain becomes a serious problem on a global scale.

Few would disagree that the pandemic exposed this reliance on semiconductors sourced from Taiwan. A similar dynamic occurred when protective gear for essential workers, much of which was made in China, was suddenly in short supply early in the pandemic.

At the same time, other areas of the economy have long had what could broadly be called supply chains or networks—think of the strategic petroleum reserve, or even the nation’s standing army. These supply networks provide essential goods or services, and cannot be outsourced to other countries. They are seen as a public good, and there is little debate over their merit.

How can that broader interpretation of a supply chain be applied to other industries that help keep the American economy functioning smoothly? International trade, after all, should benefit consumers, expand the potential for growth and ensure a peaceful coexistence among trading partners.

Critics of free trade will point to the global supply chain as increasing the well-being of populations other than our own, while the pandemic and severe weather events have exposed the fragility of any supply chain.  

We propose the creation of a North American integrated supply chain for the manufacture of essential products—not unlike the strategic petroleum reserve. Such a proposal would appear to be on the policy menu in Washington and could become an important springboard for the domestic manufacturing economy.

It would build off the groundwork already laid by trade agreements among the U.S., Canada and Mexico, and go a step further. The corporations that maintain those essential supply networks would be paid a suitable rate of return on their investment in the same manner as we regulate the return of public utilities.

Consider this example: If the U.S. has the comparative advantage of developing ventilators, and Canada has the resources for manufacturing the parts, and Mexico has the labor force for assembly, it would not be that hard to create a North American supply chain and maintain an inventory of medical equipment—ensuring that all three nations would be safer when the next version of the coronavirus arrives.

There is a precedent to a coordinated government effort targeting a particular industry. Sematech was responsible for the 1980s turnaround in the U.S. semiconductor industwry, according to an article in MIT Technology Review, and became a model for how industry and government can work together to restore manufacturing industries or help jump-start new ones.

The model for the new economy in the U.S., Canada and Mexico relies on research hubs provided by academic institutions and on production centers where that research is then put to work. Each requires an educated, healthy and skilled labor force. The result is thriving local economies like Seattle and Austin, Toronto and Vancouver, and Queretaro and Saltillo.

Government policy should be directed at developing the infrastructure for the rapid transfer of goods and ideas among those hubs and for developing the intellectual capital and health of the labor force. The events of 2020 suggest that investing in a supply chain for essential products is well within the purview of both the public and the private interest.

Joe Brusuelas is chief economist with RSM US LLP.  

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