Industrial Policy is No Longer a Four-Letter Word(Yicai Global) Dec. 14 -- With the US Innovation and Competition Act (USICA), the Biden Administration has fully embraced industrial policy. President Biden says the USICA is designed to “discover, build, and enhance tomorrow’s most vital technologies — from artificial intelligence, to computer chips, to the lithium batteries used in smart devices and electric vehicles — right here in the United States.”
In order for the US to “maintain its position as the most innovative and productive nation on Earth,” the USICA allocates USD250 billion in the following areas:
The USICA was adopted by the Senate in June. It needs to be passed by the House of Representatives and signed by President Biden before it becomes law.
A government undertakes industrial policy when it wants to improve the structure of its economy. As documented by the Cato Institute’s Scott Lincicome, these policies have had a “checkered history” in the US.
The Merchant Marine Act of 1920 (the Jones Act) was intended to increase US shipbuilding capacity and develop a supply of sailors that would be available during wartime or other emergencies. To this end, it restricts domestic shipping services to vessels that are US-built, US-owned, and US-staffed. The Jones Act leaves the US with one of the most restrictive shipping systems in the world. Analysis by the Cato Institute shows that the Jones Act inflated US shipping costs. This reduced the demand for shipping services in favour of road and rail. Reduced demand for ships meant a smaller US shipbuilding industry and a fleet that is currently quite old due to the high cost of replacement.
In the 1980s, the US implemented policies designed to support its domestic machine tool industry. The Reagan Administration concluded a series of five-year Voluntary Restraint Agreements with Japan and Taiwan in 1986 under which they limited their exports of certain machine tools. The federal government also funded research and development aimed at modernizing the machine tool industry. Moreover, Congress required the Defence Department to buy American-made machine tools. These measures failed to revitalize the American machine tool industry and cost US machine tool consumers hundreds of millions of dollars each year.
Similarly, under the 1986 Semiconductor Trade Agreement, Japan limited its exports of dynamic random access memory (DRAM) chips to the US. As a result, there was a shortage of DRAM chips and US chip prices rose significantly. This put US chip users at a disadvantage to their European competitors. Ironically, the higher chip prices benefitted Japanese producers, while the US chip industry stagnated despite high prices and government subsidies.
Given these experiences, why is the Biden Administration so keen on promoting the technological upgrade of the US economy?
Clearly, the Administration feels pressure from China. As President Biden said, “We are in a competition to win the 21st century, and the starting gun has gone off.”
For its part, China embarked on a new wave of industrial policy in 2015, with its Made in China 2025 and Internet Plus Program initiatives. While China’s ambition caused significant anxiety in the US and the EU, its desire to participate in the “fourth industrial revolution” was nothing extraordinary. According to the eminent Canadian economist Dan Ciuriak, China’s plans were modeled on Germany’s Industry 4.0, Japan’s 4.1J and Connected Industries programs, Korea’s Connected Smart Factory and the US’s Advanced Manufacturing Partnership.
China’s industrial policy, which is well-described by UC San Diego’s Barry Naughton in “The Rise of China’s Industrial Policy 1978 to 2020”, has continued to evolve. According to Naughton, China’s Innovation-Driven Development Strategy (IDDS) is based on a triangle of technologies –communication, data and artificial intelligence – rather than specific industries. He says that the three can be conceived of as a single “general-purpose technology” that could permeate the economy and increase productivity across industry, agriculture and services.
China is well-placed to adopt such a technology. It has the world’s largest mobile internet market. Moreover, it is well-advanced in rolling out its 5G infrastructure. Looking to the future, Naughton says that the new technology’s pace of diffusion will depend on China’s ability to produce high-quality semiconductors and implement artificial intelligence.
The former will be challenging. Semiconductor fabrication and design are concentrated in a small number of firms as is the production of the machines used to manufacture chips. Moreover, the US maintains export controls on semiconductor production technology “designed to keep China about two generations (2-3 years) behind the technology frontier.”
The latter will be somewhat easier. Breakthrough programs in artificial intelligence are published quickly and widely available. Naughton believes that there are few barriers from preventing a newcomer, like China, from advancing rapidly.
Naughton notes the various vehicles that China uses to support the IDDS but concedes that it is difficult to measure the full amount of government support. Public investments made via Industrial Guidance Funds are a prominent channel. Naughton estimates that, at the end of 2018, these funds were authorized to invest CNY11.3 trillion (USD1.6 trillion), or 12 percent of that year’s GDP. Ultimately, these funds may not actually invest up to their full authorization. Indeed, Naughton notes that through 2019, only 60 percent of the authorized amount may have been actually raised. Moreover, these funds will be disbursed over many years. Nevertheless, Naughton says that the “IDDS represents the greatest single commitment of government resources to an industrial policy objective in history.”
Implementing effective industrial policy is not easy. As noted above, such policies failed numerous times in the US. Moreover, between 2006 and 2013, China committed significant resources to encourage its shipbuilding industry. However, as Barwick, Kalouptsidi and Zahur document, this policy mostly benefitted foreign fleet owners through lower ship prices. In view of the difficulty in making industrial policy work, what are the prospects of China’s IDDS succeeding?
Princeton’s Ernest Liu’s research shows that industrial policy is more likely to be effective if it removes distortions in “upstream” industries – i.e., industries whose products are used by other industries as inputs. He argues that the sectoral policies implemented by South Korea in the 1970s and by China in recent times which targeted distorted upstream industries were successful in raising economic welfare.
The literature emphasizes that industrial policy is most likely to be effective if it supports a general-purpose technology. The spread of a general-purpose technology – for example electricity – has the potential to benefit the entire industrial structure. General-purpose technologies are very far upstream. However, left to the market, private firms are unlikely to supply enough of this technology. This is because they are unable to charge for the wide-ranging benefits. This under-supply is what Liu calls a “distortion” and its mitigation, through government support, provides the theoretical justification for the IDDS.
However, as Naughton points out, the IDDS has its risks. This is because China aims to move rapidly and forcefully to the technological frontier, where there are no front runners to emulate and no mistakes from which to learn. For example, if a “6G technology” emerges that is radically different from 5G, then China may have invested in white elephants.
There is something tragi-comic about the US and China engaging in a “tech race” through their competing industrial policies. The US government wants to spend a lot of money to stay ahead of China, whose government is spending even more money, in part, because it cannot obtain the technology it needs from the US.
It is possible that this tech race – like the space race before it – will accelerate the development of new and exciting products. On the other hand, a more cooperative approach might achieve the same result at even lower cost.
Mark KrugerMark Kruger is Yicai Global's Opinion Editor and Senior fellow to the Yicai Research Institute. He is also a Senior Fellow at both the University of Alberta's China Institute and the Centre for International Governance Innovation. Mark was formerly a Senior Policy Director in the Bank of Canada's International Department, a Senior Advisor to the Canadian Executive Director at the International Monetary Fund and head of the Economic and Financial Section in the Canadian Embassy in Beijing.
