Will the Biden Administration’s Industrial Policy Experiment Succeed?

Over the last couple of years, there has been a lot of talk in Washington about industrial policy. These discussions may give people flashbacks to the early years of Bill Clinton’s first term as president, when industrial policy was all the rage. There was discussion at that time about public-private partnerships, government helping with the development of emerging technologies, and support for advanced manufacturing. These policies arose in the context of concerns that the U.S. economy was being “overtaken” by Japan.

Fast forward to today, and now China is the economic threat. Once again, industrial policy is said to be necessary to compete with an economic (and this time, security) rival, as well as to fight climate change and provide jobs to the middle class — although sometimes these goals conflict (e.g., new factories lead to more carbon emissions).

Is the latest burst of industrial policy talk from policy wonks and government officials more likely to stick than the Clinton-era version, which eventually faded away?

This new edition has been accompanied by high-profile legislation related to clean energy and semiconductors, so perhaps it has more staying power. However, only time will tell where this is all headed. Regardless, the current conversations provide an opportunity to revisit some long-standing debates: Broadly speaking, what is the appropriate scope of the government’s role in directing the economy? And in more specific terms, does industrial policy strengthen the national economy and accomplish the various policy goals noted above, or does it waste taxpayer money on welfare for big corporations who would have built their factories anyway?

What is Industrial Policy?

For some people, industrial policy refers to just about all economic policy, but that’s too broad to be helpful.[1] A simple definition from industrial policy advocate Robert Atkinson is more useful: “a set of policies and programs explicitly designed to support specific targeted industries and technologies.”

If that’s the definition, there’s a good argument that we have had industrial policy all along, whether people called it that or not. The following examples show how the government has long provided economic support to a range of specific domestic industries.

In the field of intellectual property, long (and frequently extended) copyright terms are designed to give financial benefits to particular industries and companies, such as Hollywood movies and Silicon Valley software. This began as a domestic policy, with the idea that it was important to support knowledge- and creativity-based industries (industries that just happened to be well-connected and wealthy). It was later internationalized through the World Trade Organization’s TRIPS (Trade-Related Aspects of Intellectual Property Rights) Agreement and the IP chapters of bilateral and regional trade agreements, extending these policies to other countries.

In the area of manufacturing, there is a long history of using special tariffs (anti-dumping/countervailing duties/safeguards, and more recently “national security” tariffs) to support domestic industries such as steel and aluminum. For decades, such measures have been used to protect these industries from foreign competition. Trade protectionism is one of the classic examples of industrial policy.

There is certainly a robust debate about whether these and similar government actions are good policy. But there shouldn’t be much disagreement that they fall within the definition of industrial policy.

Does Industrial Policy Work?

Studies of past industrial policy efforts show serious problems with how they work in practice. Some of the problems may have been in the implementation, as this sort of government planning is complicated. In some cases, it may simply be that human error caused the policy to come up short. But beyond that, there are fundamental structural flaws with the basic idea of industrial policy that are hard to overcome.

One of the long-standing critiques of industrial policy is that it is subject to the influence of powerful interest groups, who will shape it for their own benefit and undermine the proponents’ goal of trying to act in the national interest. Could a hypothetical philosopher-king provide financial support to big corporations without lobbyists taking control and shaping the effort? Perhaps. But in our current political system, the problem of regulatory capture is real. It’s hard to see how these policies can be carried out in a way that avoids corporations, unions, and other interest groups exerting a lot of influence over the regulatory process.

It is also not clear that many of the subsidies that are at the heart of recent industrial policy efforts will lead to significantly more investment. Corporations are very adept at taking advantage of these efforts to get money for doing what they already planned to do. When governments are competing for factories through subsidies, corporations can play the governments off each other and get better deals to build the factories they already had in mind (e.g., through property tax breaks for a specific location). But there may not be much more total investment, or investment in substantially different places, than would have taken place if only market forces had guided their decisions. These subsidies may “work” politically, as each winning government can tout the “success” of having paid money and been rewarded with the announcement of a new factory. But in the absence of the subsidies, there may have been the same factories, just without the government money. This is difficult to prove, but it’s worth considering as governments publicize the announcements of “new” investments arising from their subsidies.

 Finally, if there is new investment in, say, a factory, that news gets a lot of media attention, but it’s also important to consider the other, less noticeable, effects. When the government shifts a country’s financial resources toward manufacturing, the money has to come from somewhere. If we want to invest in more manufacturing, what do we want to invest less in? Agriculture? Internet services? Biotech innovation? Natural resource extraction? These are the real tradeoffs being made when we push for more manufacturing, even if they are not often acknowledged or recognized.

International Relations Aspects

The industrial policy debate is often focused on domestic issues, but there are international relations aspects as well. The measures used to pursue industrial policy often lead to trade conflict, and international trade agreements provide constraints on measures such as subsidies, tariffs, and domestic content requirements. These trade rules offer a set of mutually agreed rules to limit the use of industrial policy.

The Biden administration’s recent policies present a challenge to these trade rules. For example, the Inflation Reduction Act of 2022 contains elements such as domestic content requirements. There used to be a clear consensus among governments that such rules should be prohibited by trade agreements, but the Biden administration appears to be pushing for a rethinking of these and other trade rules, so as to allow a wider scope for industrial policy.

Beyond trade law, there are also broader international relations issues. For those in the U.S. who advocate for industrial policy at home, what do they imagine developing countries will do in their own economies? Is it only the wealthiest countries that can and should engage in industrial policy? Clearly these countries can spend the most money on these efforts, so is the idea that the U.S. will make products and sell them to the rest of the world, with developing countries focusing on natural resource extraction? When politicians such as Elizabeth Warren say that the United States will “develop, manufacture, and export the technology the world needs to confront the existential threat of climate change,” it sounds like that’s what they have in mind.

Or is the vision that every country should have an industrial policy of its own? Each country would make its own steel, solar panels, semiconductors, shoes, etc. If taken to the logical extreme, that would be a terribly inefficient way to run the global economy.

Conclusions

A driving force behind the recent industrial policy push in the U.S. seems to be nostalgia for a past era in the American economy — perhaps the 1950s, as industrial policy advocate Congressman Ro Khanna tweeted recently, although industrial policy advocates are often vague about exactly when they would like to go back to. Regardless of the date, they seem to want to return to an era where U.S. manufacturing played a bigger role in the economy than it does now. Some proponents also appear to suggest they long for the days when one income from a manufacturing job was enough to support an entire family.

There are a number of problems with this vision. First, if we are talking about the 1950s, that was a time when the European and Japanese economies had been destroyed by World War II, so U.S. manufacturers faced an unprecedented absence of competition. These circumstances are not likely to be repeated, however, and U.S. manufacturers will face tough competition in world markets, even if industrial policy manages to limit competition at home to some degree. Industrial policy may or may not lead to a slight shift of the U.S. economy toward manufacturing, but the 1950s economy is not coming back.

Second, the U.S. economy at that time was much less inclusive than today. Women and minorities could play only a limited role due to discrimination. That led to benefits for certain groups within the economy but hardship for many others. Thankfully, we have seen significant progress since that era. For that reason as well, the nostalgia for a past economy is misplaced.

If we are going to do industrial policy, there are better and worse approaches. For example, subsidies that go directly to consumers (e.g., tax breaks for buying an electric vehicle) are better than subsidies to specific producers, as producers are highly skilled at regulatory capture. Thus, if fighting climate change is the goal, then a “light touch” industrial policy that favors the clean energy vehicle sector as a whole — by subsidizing purchases of its products rather than giving subsidies directly to individual auto manufacturers — makes the most sense.

For a mix of reasons, the Biden administration is going forward with many of the initiatives it labels as industrial policy. As noted, studies of past efforts show serious flaws in these policies, but it is all being tried again, so there will now be a chance to do some new assessments. What we need is an objective evaluation of these efforts. How well are the policies achieving their stated objectives? Are there unanticipated effects?

Industrial policy is being put to the test. Let’s use this opportunity to give it another thorough evaluation.

Endnote

[1] For a comprehensive discussion of the concept, see the Cato Institute white paper by Scott Lincicome and Huan Zhu, “Questioning Industrial Policy,” Cato Institute, September 28, 2021, https://www.cato.org/white-paper/questioning-industrial-policy.

This material may be quoted or reproduced without prior permission, provided appropriate credit is given to the author and Rice University’s Baker Institute for Public Policy. The views expressed herein are those of the individual author(s), and do not necessarily represent the views of Rice University’s Baker Institute for Public Policy.