The Critique of the New Industrial Policy

Industrial policy has risen to prominence on the national agenda in the U.S. and other advanced industrial economies. This marks a significant departure from recent economic trends and has reignited a longstanding debate in which we were both actively engaged over three decades ago.

In the U.S., the CHIPS and Science Act, the Inflation Reduction Act (IRA), and the Bipartisan Infrastructure Act have established noteworthy national security and climate objectives. Each of these acts utilizes subsidies, tax credits, loan guarantees, and other conventional industrial policy tools to promote research, production, and employment within the private sector, specifically targeting crucial sectors of the economy.

These instruments are currently employed under vastly different circumstances compared to 30 years ago. In the past, industrial policy aimed for national self-sufficiency, often driven by mercantilist objectives. However, today, due to the prevalence of intricate global supply chains and China’s emergence as a formidable geopolitical and economic competitor, the concept of national sovereignty, defined as vertically integrated domestic capacity owned by nationally-owned firms in specific sectors, is simply impractical.

Instead, the industrial policy for the twenty-first century needs to adapt to new global conditions by focusing on two primary objectives.

  • Ensuring a sufficient and competitive supply of products and technologies crucial for attaining economic prosperity and security.
  • Establishing a foothold in the advancement and implementation of next-generation technologies that play a pivotal role in both national security and the transition to a carbon-neutral economy.

Recognizing that a fully vertically integrated national supply system is unrealistic, these objectives necessitate the United States and other advanced economies to utilize industrial policy strategically, aiming to attain significant positions of influence in markets for specific products and technologies deemed strategically important on both economic and geopolitical fronts.

The Purpose of the Industrial Policy

Industrial policy often faces criticism from economists who view it as a costly form of protectionism, capable of distorting markets and impeding the efficient allocation of scarce resources. However, the context plays a crucial role. In the presence of externalities, industrial policy can serve as a corrective measure for markets rather than a distortion. Moreover, in a landscape marked by concentrated global market power and rapid technological evolution, industrial policy can be seen as a positive-sum game. It has the potential to accelerate technological innovation and deployment while simultaneously fostering increased global competition and expanding markets.

The characterization of industrial policy as protectionist or zero-sum arises when it is formulated to restrict trade and cross-border investment, aiming to shield domestic producers or “national champions” from foreign competition. On the other hand, it becomes preferential rather than protectionist when it encourages domestic production over foreign production. It’s crucial to differentiate between “domestic” in terms of location and “domestic” in terms of company ownership. The design of US industrial policy intentionally benefits both domestic and foreign companies engaged in investment and production within the US. For instance, incentives like those in the CHIPS and IRA apply to foreign companies establishing their production in the US, as long as they are not categorized as “foreign entities of concern” (indicating ownership or control by the Chinese, Russian, North Korean, or Iranian governments).

In the presence of negative externalities, markets fall short in reflecting the complete economic costs and benefits associated with private actions. Decisions guided solely by market logic and business profitability neglect considerations such as national-security concerns or the economic, social, and health-related costs tied to climate change. It is unrealistic to expect private businesses to address public goods provision or tackle negative externalities like the emission of planet-heating greenhouse gases. These responsibilities rightly rest with governments, which possess compelling rationales for industrial policy, both in semiconductors and other dual-use foundational technologies, as well as in green technologies, products, and services.

We contend that industrial policy serves two crucial purposes:

  • To integrate national security and climate-change externalities into market decisions
  • to foster market competition and innovation, cultivating resilient, secure, and sustainable global supplies of critical products and technologies

Indeed, with regard to sustaining competitive global markets, industrial policies from advanced economies become increasingly necessary to counterbalance efforts by countries like China to establish dominant positions in global markets, particularly in critical sectors.

Contrary to the perception that industrial policy harms markets, it has the potential to not only expand markets but also promote trade and ensure resilient, secure, and sustainable supplies. This is achieved by fostering competition, research, and innovation in specific sectors where progress might otherwise be slow or nonexistent.

Evaluating the Advantages

A notable instance is the EU’s industrial policy, which played a pivotal role in the development of Airbus. This initiative spurred competition and innovation in the global civilian aircraft market, which had long been dominated by a single US supplier (Boeing), itself a beneficiary of substantial industrial-policy support. Similarly, the biotech industry offers numerous examples of market-expanding and market-creating industrial policies. In the United States, generous support, both through significant public funding for research and development and the absence of drug-price regulation, has resulted in a policy mix that created a highly profitable market for biotech products and positioned the US as the global hub for medical and pharmaceutical innovation.

These types of market-expanding industrial policies are designed to afford a country leverage and a robust foundation in the advancement and implementation of next-generation technologies. However, the success of such policies hinges on sufficient funding for basic scientific research, applied R&D, and the cultivation of talent.

Both CHIPS and the IRA are designed to provide this essential support. An often-overlooked aspect of CHIPS is that approximately 70% of its funding, amounting to $200 billion over the next decade, is specifically allocated for research, workforce development, and the commercialization of cutting-edge technologies. This funding extends beyond semiconductors, encompassing other dual-use areas such as 5G, quantum computing, clean energy, and artificial intelligence.

The new US industrial policy also serves as an example of how international collaboration on the development of next-generation technologies can allay concerns that such strategies are inherently protectionist. For instance, CHIPS allocates funding for the recently introduced Microelectronics Commons, a network of innovation hubs that brings together researchers from academia, government labs, and businesses to advance microelectronics discovery, innovation, prototyping, and eventual commercialization. Importantly, any foreign company not on the “concern” list is eligible to participate.

Furthermore, the architects of CHIPS recognized that achieving competitive, resilient, secure, and sustainable supplies necessitates investment not only in physical and knowledge capital but also in people. For industrial policy to fulfill its intended role of expanding market competition and fostering innovation, it must incorporate provisions for workforce development. A case in point is TSMC (Taiwan Semiconductor Manufacturing Company), the global leader in advanced semiconductor chip production, which recently cautioned that a shortage of qualified talent is not only delaying the opening of its new fabrication facility (“fab”) in Arizona but also significantly increasing its costs. The Semiconductor Industry Association anticipates that, in the next decade, nearly half of the positions for technicians, computer scientists, and engineers may go unfilled due to a shortage of qualified workers.

To address this workforce shortfall, the US National Science Foundation, renowned for its merit-based decisions, has been entrusted with disbursing CHIPS funding for workforce development. As an illustration, the NSF recently announced a $45 million public-private partnership, including participation from foreign companies such as Ericsson and Samsung, aimed at providing competitive research and education awards.

The Global Perspective

When we assert that industrial policies can promote competition, we’re not limiting the scope to domestic arenas; the impact extends globally. Much like Airbus in Europe, TSMC is a product of Taiwan’s own economic strategy. These instances demonstrate that a state’s efforts to enhance supply, encourage innovation, and cultivate robust national companies in targeted sectors often prompt others to formulate their own policies to “level the playing field.”

In reality, the industrial policies of the US and the EU targeting semiconductors and climate-related technologies are responses to China’s state-supported initiatives to attain market and geopolitical dominance in strategic sectors. The example of OPEC highlights the risks and costs associated with global market power wielded by a group of countries over a pivotal input like oil. Semiconductors, critical minerals, and batteries—all industries in China’s crosshairs for market dominance—are vital components for digital and green industries in the US and other advanced economies. Responding with policies to maintain global markets competitive, resilient, and secure for these crucial products and technologies is a prudent move for the US and its allies.

Currently, market forces and private decisions have left the US economy excessively reliant on advanced semiconductors produced by a single company (TSMC) in a single location (Taiwan), carrying significant geopolitical risk. Furthermore, the US and its European allies share a considerable dependence on China for batteries, as well as for key minerals and rare earth elements essential for wind turbines, solar panels, electric-vehicle batteries, and more.

Chinese market dominance in these sectors poses a substantial threat to the resilience and security of supply chains, along with the national and economic security of the US and Europe. In early July, China’s Ministry of Commerce imposed new restrictions on the exports of germanium and gallium—minerals crucial for semiconductors and EV batteries—citing the protection of its own “national security and interests.” As a leading global producer of both metals (including 94% of the world’s gallium), China has demonstrated its capacity to disrupt critical supplies to the US and Europe.

Balancing Risks and Costs

While there is a compelling economic and geopolitical argument in favor of market-expanding industrial policies, there are inherent dangers that need careful consideration. The notion of building a “high fence” around a “small yard,” as suggested by US National Security Adviser Jake Sullivan, simplifies the complex challenge. A catchy metaphor doesn’t provide clarity on which technologies and sectors should be included, how to maintain the yard’s size, or who will make such determinations.

Acknowledging the genuine concerns of political capture by special interests and the rise of crony capitalism is essential. The risk is particularly pronounced in the US, where business spending on lobbying exceeded $4 billion in 2022, a significant increase from around $1.5 billion in 2000. With the Supreme Court endorsing unlimited political donations by corporations and wealthy individuals, there are minimal constraints on the influence-peddling process. Simultaneously, years of outsourcing and fiscal restraint have left the US government with a diminished administrative capacity for formulating and executing industrial policy. Consequently, there is now a need to rebuild those capabilities from the ground up.

In its efforts, the federal government should explore a public-partnership strategy for investing in key sectors, leveraging the robust strengths of US financial markets. Specifically, establishing a US federal government investment fund, managed by a professionally insulated team, could efficiently allocate industrial-policy subsidies among competing companies and technologies.

Numerous countries with substantial industrial policies already operate sovereign wealth funds, and certain US states, such as Alaska, New Mexico, and Oregon, have dedicated funds for various purposes. As the proprietor of this new federal investment fund, the US government would participate in both the gains and losses of its portfolio. This marks a positive departure from the current approach, where the government lacks a stake in the returns generated by private companies or investors benefiting from public subsidies, tax credits, and other federal industrial policies.

Given that the government is providing the funds, it is reasonable for it, and by extension, the American people, to share in some of the benefits. This approach would further augment resources available to foster competition, innovation, and resilience in the twenty-first-century economy.

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