Cold War II: Should the US embrace high-tech industrial policy to counter China? An AEIdeas online symposium

In a long essay in National Review this month, Michael Lind issues a call to arms. We are in a new Cold War with China, and must respond accordingly. Geopolitics and geo-economics must be one; the neoliberal Washington Consensus of the post-Cold War era no longer cuts it. Here’s what he says we need in its place:

Instead of letting state-capitalist nations such as China or profit-seeking multinationals restructure the U.S. economy to promote their own goals, the American republic needs a national industrial strategy of its own. To be precise, it needs to return to the time-tested and successful Hamiltonian industrial strategy of using whatever means are necessary — tariffs, subsidies, procurement, tax breaks, even overseas-development loans to countries that purchase U.S. manufactured exports — to ensure that strategic industries necessary to U.S. military power are introduced to America or remain here. . . .

With its Made in China 2025 initiative, the Chinese government has announced a push for Chinese leadership in ten key industries, including advanced information technology, aviation, rail, pharmaceuticals, and others. This should be a Sputnik moment for the U.S., inspiring Americans to identify and promote not specific companies but key “dual-use” industries important in both defense and civilian commerce.

To discuss this thesis, I asked five experts on economics, innovation, and China to answer this question: “Does China’s bid to become the world’s leading technological and economic superpower necessitate a more state-directed economic program on the part of the US? And if so, what should this new national economic policy entail?”

Robert Atkinson, President of the Information Technology and Innovation Foundation, and co-author with Michael Lind of “Big is Beautiful: Debunking the Myth of Small Business.” 

The fact that this question is framed the way it is — do we need a state-directed economy instead of our current system — points to the very problem facing the United States in its geo-political/economic challenge with China. In the United States, the choice is almost always framed as either become like China — heavy-handed and mercantilist — or remain a pure and unadulterated free market, shining city on a hill, sullied only by crony-capitalist inspired deviations like the Export-Import Bank.

In fact, China is not so much a state-directed economy as a state-enabled one. China generally lets its “capitalist” companies make the investment decisions they want and then supports them with purloined technology, massive subsidies, and a protected domestic market. And ever since Alexander Hamilton’s first report on industrialization, the United States has employed domestic policies to industrial restructuring.

The problem today is that too many on the right are committed to an Ayn Rand vision of unfettered, noble capitalists where markets alone maximize economic welfare. And too many on the left are committed only to a project of ensuring that discriminated identity groups are privileged.

The reality is that if we are to avoid losing not only most of our existing advanced industries (such as aerospace, biopharmaceuticals, computers, internet, and semiconductors) but also our leadership in emerging industries (such as artificial intelligence, 3-D printers, grid-scale batteries, drones, robotics, electric vehicles, and quantum computing), America needs its own national advanced industry strategy.

In innovation-based industries where success depends on robust profits to continually reinvest in the next cycles of innovation, massively subsidized Chinese competitors, enjoying protected markets and purloined foreign technologies, represent an existential threat to US advanced industry companies. Some will say, “Who cares? After all, computer chips, potato chips, what’s the difference?” Try fighting a war with “potato chips.” Try supporting millions of high-wage jobs with “potato chips.”

One final point: Picking winners does not, and should not, mean picking individual companies, Qualcomm or anyone else. It does mean picking critical industries and technologies and supporting them with robust investments, particularly in pre-competitive, public-private R&D partnerships. If that is picking winners or “industrial policy” so be it.

 

Claude Barfield, resident scholar and former consultant to the office of the US Trade Representative.

For those of us of a certain age (old), Michael Lind’s call for a new industrial policy and support for leading-edge national champions brings back a cascade of (bad) memories. Periodically, the US goes through a period of panic, fearful that some other nation is catching up with us technologically, portending dire future results both economically and militarily. Three decades ago, it was a resurgent Japan; today it is a rising China, which unlike Japan is a potential future foe.

Here are lessons from two episodes in the 1980 and 1990s. First, in echoes to today, the semiconductor industry (and more specifically DRAM, or low-end “dumb” chips) were the object of intense pressure for government intervention, subsidy, and protection in order to counter future Japanese dominance. There were two significant results: First, under the 1987 US-Japan semiconductor agreement, which set a high floor price on imported DRAMS, the US ended up transferring some $4 billion from US businesses and consumers to the Japanese semiconductor industry. Second, through the auspices of Sematech, a government-business consortium, the federal government poured hundreds of millions of dollars to advance manufacturing of semiconductors, with little result to show for its largesse — except to provide a cover for semiconductor companies to meet and “discuss” market conditions without fear of antitrust action. The military component was a central culprit: A Defense Science Board report had argued (with stunning inaccuracy) that DRAM chips were key to the future of the semiconductor industry.

Then, briefly, there is the ill-fated attempt by the Clinton administration — using national security in part as a defense of its action — to create a flat-panel television screen industry out of whole cloth. The purported goal was an independent high-tech supply of advanced screens for US fighter and bomber pilots — even though these screens would never amount to even a tiny percent of the total market. Japan controlled some 90 percent of the world market, with the Koreans beginning to challenge them. The Clinton administration proposed to spend several billion dollars to create a group of flat-screen plants around the country, and it laid out an ambitious agenda to reach the goal of some 10–15 percent of the world output. Luckily, in 1995, a new Republican Congress buried this wildly unrealistic program. As with semiconductors, national security had been invoked to gain support for an economically irrational program.

Expect the same as the panic over Chinese techno/military advances proceeds apace. But Samuel Johnson’s dictum still holds: “Patriotism (read today: national security) is the last refuge of a scoundrel.”

Amar Bhide, Professor at the Fletcher School of Law and Diplomacy at Tufts University, and author of “The Venturesome Economy: How Innovation Sustains Prosperity in a More Connected World.“

Technological advances impel an irrepressible expansion of the state. The invention of the automobile, for example, necessitated driving rules and a system of vehicle inspections, and air travel required a system to control traffic and certify the air worthiness of aircraft.

Modern technology created new forms of pollution that didn’t exist in agrarian economies. Governments had to step in, in one way or the other, to make it unrewarding to pollute. Likewise, antitrust laws to control commercial conduct emerged after new technologies created opportunities to realize economies of scale and scope — and realize oligopoly or monopoly profits. These opportunities were largely absent in preindustrial economies.

Technology also expands the government’s bedrock responsibility of protecting the nation against external threats. Military aircraft required the establishment of an Air Force and the internet defenses against cyber-attacks.

Reciprocally, governmental agencies with more responsibilities and resources have catalyzed the new technologies. Efforts to hunt down submarines prompted the development of ultrasound detection, which was then used in industries to detect flaws in metal structures and in medical diagnosis. IBM’s prowess in data processing has its roots in a project to automate Social Security disbursements. The US Defense Advanced Research Projects Agency (DARPA) famously seeded the internet.

But because some expansion of government is good doesn’t mean a lot must be great. Efforts to promote nebulous goals of technological primacy or industrial competitiveness, rather than fulfill a specific agency mandate, tend to be wasteful or worse. For instance, ultrasound units for battlefield use that DARPA funded in 1996 were enthusiastically adopted by civilian paramedics and physicians who used the compact devices to perform lifesaving procedures where emergencies occurred. In contrast, an earlier National Science Foundation (NSF) program in 1974 to keep US companies from falling behind in ultrasound technology was totally ineffective.

Investing in tomorrow’s markets or technologies requires acting on hunches and adapting to unexpected developments. Government agencies expected to act fairly, openly, and defensibly are ill-suited to do this. Moreover, no one — astute entrepreneurs, experienced venture capitalists, and storied high-tech firms included — can reliably pick winners. Google (now Alphabet) has promoted several failed offerings — remember Google Video Player, Google Buzz, Google Wave, and Google Answers?

Therefore, putting many independent experiments in play raises the odds that one will work. When government gets into the game of placing bets — for instance on new battery technologies — innovators who don’t have the savvy, credentials, and connections with politicians or the scientific establishment are at a severe disadvantage. Yet history shows that it’s often the non-conformist outsiders who play a pivotal role. Would Ed Roberts have been able to secure a government grant to build the world’s first personal computer — a virtually useless toy when it was introduced in 1974?

Entrepreneurial “leaps into the dark” are best sustained by great caution in expanding the scope of government intervention — the private virtue of daring can be a public vice. The US chief justice has often repeated the maxim: “If it is not necessary to decide an issue to resolve a case, then it is necessary not to decide that issue.” Similarly, if it is not necessary to intervene to promote innovation, it should be considered necessary not to intervene. The government should focus on things that private enterprise simply cannot provide and stay away from promoting activities that would allegedly be undersupplied.  If nothing else this maxim frees up resources for crucial public goods — our crumbling roads and bridges, for instance.

An authoritarian regime in China may think it can succeed where techno-nationalist savants in Japan’s Ministry of Trade and Industry repeatedly failed. But this is a bad example for us to copy.

Derek Scissors, resident scholar and chief economist of the China Beige Book.

I was a China critic before it was cool. An important reason not to allow Qualcomm to be acquired was competition with the People’s Republic. Even so, the US becoming more statist in response to PRC statism is a mistake. Instead, we should double down on our advantages, by sharpening competition and protection of property rights.

The PRC seeks to match or surpass the US technologically and economically through state intervention. The Chinese state spends heavily, primarily through its banks, in what are identified as strategic sectors. It conditions access to the Chinese market on transfer of technology. At best, it permits theft of foreign intellectual property (IP), at worst it suborns it.

The US should retaliate. With China effectively closing its market through protection of state-owned enterprises and coercive technology transfer, the US is not obligated by any reasonable standard to open our market fully to Chinese goods, services, capital, or people. Moreover, Chinese firms benefiting from theft of US IP should face severe sanctions.

But retaliate, do not imitate. That the PRC has harmed the US does not mean statism works. As the Bank of International Settlements measures it, from the end of 2000 to the end of the third quarter of 2017, Chinese government debt increased by a factor of 20. Under Presidents Bush, Obama, and Trump — none known for fiscal responsibility — US government debt rose by a still-excessive factor of 3.7.

At the end of Q3-17, US credit to the non-financial sector had the same ratio to gross domestic product as it did at the end of the Q3-10: 2.5:1. The Chinese ratio climbed from 1.8:1 to just above the American level. China is also an aging, resource-depleted, and still poor country.

We should not let them drag us down with them. We need to reward and protect innovators, from advanced technology to tweaks in a garage. Washington’s role should be to enforce the law and support basic research — not, as Beijing does, to decide what sectors are important and support the biggest companies.

Related and more fundamental, the US needs more competitors, not national champions. Qualcomm, Intel, Boeing, and a few others must be protected from foreign control for now, but have become too important. If federal money is spent, it should be on seeding competitors for some products or services now made exclusively by one company. Competition will beat the state, yet again, if we let it.

 

Scott Sumner, Director of the Program on Monetary Policy at George Mason University and author of the economics blog The Money Illusion.

Back in the 1980s, many experts insisted that Japan’s economy was about to surpass the US. Pundits such as Lester Thurow argued that we needed to adopt a Japanese-style “industrial policy,” featuring more government intervention and/or mercantilism. In fact, the long Japanese boom was about to come to an end, as Japanese GDP per capita (PPP) peaked at about 75 percent of US levels in the early 1990s, and then fell back modestly. The US went on to dominate the global high tech sector, as Japanese firms such as Sony fell behind even South Korean competitors like Samsung. Picking “national champions” is not a good way to create successful high tech firms.

Today we hear the same sort of claims about China, a country with a per capita GDP barely 1/4th of US levels. Admittedly China is growing quite fast, and will reach significantly higher income levels in the next few decades. But China has little chance of overtaking the US in per capita GDP, or in the commanding heights of high tech, unless it changes its economic structure to become more market oriented. Rather than the US copying China, it makes more sense for China to move its economy in a more free-market direction. Indeed, I expect it to do so.

There is a very strong correlation between GDP per capita and economic freedom. The few countries that have a higher per capita GDP than the US are usually either oil rich countries with tiny populations or places that score even higher than the US in terms of economic freedom, such as Singapore and Switzerland. This isn’t to say there is no role for the government in promoting economic growth — funding of basic research can be helpful — but rather that we should not change our fundamental economic model to become more interventionist, at a time when the more statist developed economies in Europe and Asia have been falling behind the more market-oriented economies in those regions.

Free-market capitalism has never been particularly popular with intellectuals, but the world has yet to discover a more effective economic model.