The Threat From China Means Conservatives Must Rethink Industrial Policy

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When the idea first surfaced in the late 1970s that the United States should adopt a national industrial policy, mainstream “free market” conservatives decried it as one step away from handing the reins of the economy over to a state planning committee like the Soviet Gosplan. But now, with China rising as a challenger to U.S. economic and national security, the idea has been getting a fresh look among some conservatives who argue that, absent an industrial strategy, America will be at a competitive disadvantage.

Oren Cass, the former head of domestic policy for the Romney presidential campaign and a senior fellow at the Manhattan Institute, articulated the case for it at this summer’s National Conservatism Conference in Washington, DC, when he explicitly took the position that “America Should Adopt an Industrial Policy.” And he’s right: In this new environment, conservatives should at least keep an open mind.

However, over the next decade, as economic competitors like Germany and Japan began to challenge the United States in consumer electronics, autos, and even high-tech industries like computer chips, the focus of debates about industrial policy broadened to encompass overall U.S. competitiveness. Indeed, as Margaret O’Mara highlights in her new history of Silicon Valley, by the early 1980s many of the Valley’s business leaders – even diehard, small-government Republicans – were urging Washington to be more active, especially to challenge Japan’s rise in computing.

There was a bipartisan response also, with the Carter, Reagan, and George H.W. Bush administrations enacting a wide array of proposals that collectively amounted to a first draft of a national industrial policy, often urged by Congress. It included the research and development tax credit, a significant expansion of the Small Business Innovation Research Program, the revision of the Prudent Man rule to let pension funds more easily invest in venture funds, the repurposing of the National Institute of Standards and Technology, creation of programs to help manufacturers, establishment of university-industrial partnership programs at the National Science Foundation, and the establishment of SEMATECH, a joint government-industry partnership to regain competitiveness in the semiconductor industry.

Perhaps the most important component was President Reagan’s significant expansion of defense-based research and development, including a major computer chip initiative to counter Japan’s rising influence in the sector. As O’Mara writes, between the early 1980s and early 1990s, federal funding for computer science research more than tripled, mostly through the Department of Defense.

But as the economic challenge from Japan receded — in part because of the success of these policies — and as the national security threat from the Soviet Union collapsed, interest in industrial policies waned. With Silicon Valley powering the Internet wave of the 1990s, most pundits thought America had solved its competitiveness problems. Indeed, many economists went so far as to deny that national economies even competed with each other. Moreover, as the First Gulf War demonstrated, America’s military might was so overpowering that there was little to fear from foreign adversaries. Both factors led most to believe that America was riding high, unchallenged either economically or militarily. In this environment, the sentiment was “Let freedom ring!” There was no need for government intervention.

Reinforcing this predisposition was the dethroning in the 1970s of Keynesian economics as the prevailing economic theory, with supply-side, or more broadly, neoclassical economics taking its place. The newly dominant neoclassical economists preached that the U.S. “recipe” of free markets, property rights, and entrepreneurial spirit inoculated America against any and all economic threats. Our recipe was widely seen as the only valid one for producing prosperity, and since the U.S. “chefs” had perfected this recipe to a greater extent than any other nation, there was nothing to worry about.

On top of that, there was a prevailing view that foreign economic recipes were inherently flawed and could not generate real competition. As one leading Republican House subcommittee chairman stated when asked if we should worry about economic competition from China, given the extent of its unfair, mercantilist practices: “Adam Smith proved that mercantilists only hurt themselves; so they can’t hurt us.”

Finally, with the rise of deep globalization and globalist beneficiaries — whom Harvard’s Rosabeth Kanter described as “cosmopolitans” (who travel and do business in glittering cities around the world, in contrast to “locals” who are rooted to their home communities) and David Goodhart called “nowheres” (who are happy to pull up stakes and chase opportunities wherever they may be, in contrast to “somewheres” who are determined to stay where they’re from) — the new metric for good economic policy was whether it maximized global welfare, not necessarily American welfare. Once the global marketplace became the reference point, it became harder to assert there were market failures that required industrial policy responses.

For example, when Robert Lawrence, a former member of Clinton’s Council of Economic Advisors, stated that America didn’t need a policy to spur more science and engineering degrees because that would distort the free market that was readily producing French literature majors, he was assuming that any domestic shortage would be solved by foreign students either moving to the United States or U.S. firms moving to them. But the problem with the globalist framing is that most Americans are not cosmopolitans, they are locals. They want elected officials to defend American workers, not Chinese or Indian workers.

But that was then and this is now — a now where we face intense competition from China. Indeed, China’s determination to dominate the global marketplace changes everything, especially how industrial policy is viewed. Increasingly leaders across the political spectrum are returning to a notion that we should put the national interest at the center of economic policies, and that free-market globalization doesn’t necessarily do that, especially when it enables China to challenge the United States for global leadership in an array of advanced industries, many critical for national security.

Conservatives increasingly realize that without some kind of industrial policy the United States will fall behind China, with significant national security and economic implications. Conservative Senators Josh Hawley (R-MO), Marco Rubio (R-FL), and Todd Young (R-IN) all have introduced proposals responding to these new realities. Senator Hawley introduced legislation to place a “market access charge” on foreign purchase of U.S. stocks and bonds so the value of the dollar is not artificially inflated to the detriment of U.S. exports. Senator Young has introduced the National Economic Security Strategy Act (S.2757), which would require the president to establish an economic strategy to support national security. And Senator Rubio has proposed legislation to reauthorize the Small Business Administration to make it more of a tool for national competitiveness.

Moreover, Senator Rubio recently released an important report, “Made in China 2025 and the Future of American Industry,” that makes three key points. First, the Washington establishment turned a blind eye to the China challenge for far too long; it’s now time for decisive action. Second, the choice should not be between rolling back China’s innovation mercantilism or spurring more innovation and productivity at home; America must do both. Third, it’s a mistake to posit that the only two choices for domestic policy are laissez faire, free-market capitalism or heavy-handed “industrial policy.” That was always a false dichotomy, but never more so than now. Helping companies compete globally, particularly in advanced industries, does not necessarily mean engaging in “inappropriate industrial policy,” as some on the right claim, nor does it constitute wasteful “corporate welfare,” as some on the left would argue. Done well, it is about judiciously strengthening markets and U.S. firms in the national interest.

So, what would a conservative-inspired, market-strengthening industrial policy look like? First, it would acknowledge that America’s “traded sector” industries are critical to our future competitiveness and national security. Our airlines, car dealers, and pharmacies are not threatened by unfair Chinese industrial policies, but our aviation, auto, and pharmaceutical companies are. Without vibrant traded sectors — industries that sell in both global and domestic markets — American imports would skyrocket and exports would tank, leading ultimately to a debased currency. And it would have critical implications for national security. Do we really want the Defense Department buying the key components for tanks, ships, and jets from China?

For some free-market advocates, what a nation makes is irrelevant. If we weren’t to make electronics anymore, that’s okay. Because the market ordained it, they would be content to let U.S. workers be “hewers of wood and drawers of water,” the very thing Alexander Hamilton warned against. They would do well to consider Adam Smith’s words in The Wealth of Nations: “defense is more important than opulence.” That is, if freedom of trade, investment, and the movement of people harms national security, the latter should come first.

But this gets to a key question: must industrial policy involve a trade-off between defense and opulence? No. The right industrial policy will advance prosperity more than laisse-faire capitalism would.

How can this be true? Don’t markets always get it right?  There are two principle reasons why they don’t always, one domestic and one foreign.

The domestic reason is simple: Especially in complex, innovation-based industries, there are a significant number of market failures around innovation, including externalities, network failures, system interdependencies, and the public-goods nature of technology platforms. For example, companies investing in research don’t capture all the returns, even with robust intellectual property protection. A plethora of studies have found that the rate of return to society from corporate R&D is at least twice the rate of return that the companies making the investments receive. So, absent policies like the R&D tax credit and pre-competitive R&D grants, companies will underinvest in research. Indeed, this is why only government can “pick winners.” Consider two technologies, one that provides business with a rate of return of 20 percent and no spillovers to society and another that provides business with a 10 percent return and society a 50 percent return. Without a policy to target the latter technology, business will undervest in it and America will be poorer.

The foreign justification for a U.S. industrial policy is even more straightforward. Even if industrial policy was not needed at home, its presence overseas, especially the predatory, mercantilist version nations like China practice, requires a domestic response. It’s cold comfort to the U.S. firms and workers who are hurt by foreign industrial subsidies to be told, “Don’t worry, those subsidies were market-distorting and inefficient.” Besides, all foreign advanced nations now recognize that they need industrial policy as economic competition intensifies, especially for advanced industries. For America not to have its own policies would be akin to a soccer team taking the field without coaches, trainers, or a game plan; they’re just a collection of players (businesses) running around, competing against other players (businesses in nations with effective innovation policies) that are better equipped, well coached, and running specific, well-designed tactical formations.

This is not to say that bad industrial policy could not produce worse outcomes. But embracing industrial policy does not have to mean emulating China’s heavy-handed industrial policies. Indeed, there are multiple varieties of industrial policy. The U.S. version should be for government to wisely and judiciously support private sector growth in key industries and technologies for U.S. economic and national security. It should not be picking specific firms as national champions or narrow technologies (e.g., lithium-ion batteries) to support. It should mean allowing companies to expense for tax purposes their investments in new equipment and expanding the tax credit for investing in scientific and engineering research. It should mean helping entrepreneurs better access discoveries made by U.S. universities and federal laboratories. It should mean expanding supports for exporters by ensuring the Ex-Im Bank has adequate lending authority, among other things. It should mean dramatically expanding the Manufacturing USA program, which funds pre-competitive research in partnership with companies and universities in key areas like 3D printing, lightweight materials, and robotics.

Isn’t this “picking winners,” the cardinal sin according to some free-market conservatives? It depends on one’s definition. Some take the idea to extremes and argue that the even the R&D tax credit is industrial policy because it uses government incentives to “distort” business investment decisions, even when economists clearly show that there is a market failure when it comes to business R&D. And when it comes to targeting technologies, it doesn’t take a genius to understand that some technologies, like robotics, new materials, and artificial intelligence, will be critical for America’s economic future.

At the end of the day, this debate boils down to a fundamental choice for conservatives: small government and liberty versus stronger, but still constrained, government that delivers economic security, national security, and freedom. We chose the latter in the Cold War and had elements of the kind of industrial policy we need today. Indeed, in the early 1960s, the federal government invested more in R&D than all other nations’ public and business funding for R&D combined. And that goes a long way in explaining America’s technological lead to this day. However, the fall of the Soviet Union created a unique interregnum, at least in recent American history: a United States without an external threat. The receding of economic and military adversaries let liberty rise to be the top economic concern. But now American economic freedom and national security doesn’t look so unassailable, and while our principal adversary today may not be as imperialist as the Soviets, China is potentially an even greater threat given its size and much more successful technology economy.

New times require new thinking, and that is what an increasing number of Republican members of Congress are providing. Rather than attempt to squelch these ideas and proposals with ideologically constrained thinking, scholars, pundits, and advocates should embrace them and engage in pragmatic policy discussions to make today’s industrial proposals even better.

Robert D. Atkinson (@RobAtkinsonITIF) is president of the Information Technology and Innovation Foundation, the leading think tank for science and technology policy.

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