Industrial Policy and the Temptation of Autarchy

__Originally published in Italian in Aspenia 91, December 17, 2020 by Aspen Institute Italia, with the title__ “La Tentazione Autarchica della Politica Industriale.”

Two related, long-term developments coalesced in the 2016 presidential campaign and contributed substantially to the election of Donald Trump: the maturing, expansionist economic power of China and the erosion of the US manufacturing base. Trump skillfully exploited the acute sense of decline and despair among the working-class population connected to this sector, and rode the votes of blue collar workers in the heavily industrialized Midwest to the White House. In 2020, despite major changes in US trade and economic policy since 2017, many of the same questions and fears haunt the electorate and indeed are accentuated by the impact of the global pandemic.

Both major party candidates are committed to robust new efforts to recreate what Trump has labeled a “manufacturing superpower.” Democratic candidate Joe Biden has been deeply critical of Trump policies which he labels as failures, but his campaign intends to double down on many of the trade and industrial policies that Trump initiated.

After nearly four years of the Republican administration, what are the results of Trump’s programs to revive manufacturing? And what can we expect in 2021 and beyond based on the rhetoric of both candidates? Is it realistic to think the United States will witness anything approaching a new industrial renaissance, and what policies might be effective in promoting such an outcome?

Trump and Manufacturing 2017-2019

The first few years of the Trump presidency did see a modest uptick in the performance of domestic manufacturing. It is important to note that while the measured output of US manufacturing is only around 12 percent of gross domestic product (GDP) and represents less than 10 percent of direct employment, down from 16.5 percent in 1990, the impact of this sector is much broader than the numbers suggest. In the age of globalization, the compression of profits due to intense competition from lower-cost producers such as China and Mexico, led domestic firms to outsource much of their vertically-integrated domestic operations: from parts production and maintenance to accounting and logistics. When the full impact of producing goods and distributing them around the world is computed, the total impact of manufacturing in the US economy is closer to 30 percent of GDP. Additionally, this sector is the locus for over two-thirds of all research and development performed in the United States and the source of well over half its patents. This is not surprising when we consider that dynamic, innovation- oriented sectors like pharmaceuticals, semiconductors, aerospace, chemicals, computers, and autonomous vehicles are leading components US manufacturing.

After Trump took office in 2017, there was some measurable improvement in US manufacturing: direct employment grew by about 600,000 jobs, or 5 percent, through 2019, whereas the Obama administration saw the net loss of 200,000 jobs. At the outset of his presidency, Trump signaled strong support for industry by reversing or modifying many regulatory constraints on manufacturing and related extraction industries. Tax incentives and trade policy both favored domestic production. Overall business confidence was extremely favorable to investment, especially among newly created and small businesses which account for the bulk of job creation. As unemployment fell to record lows, wage growth among the lower two quartiles of the labor force began to outpace those in higher wage sectors for the first time in decades.

New investment in the oil and gas sector, riding the “animal spirits” engendered by regulatory and tax policy, and encouraged by Trumpian rhetoric, boomed and in turn spurred associated industries including metals, machinery and construction. The growth of the chemicals industry was invigorated especially by steady increases in natural gas and petroleum liquid production. Over $200 billion in new investment in oil and gas processing plants and liquid natural gas facilities was put in place over the last decade. Much of the capital for this sector came from European and Pacific Rim countries. The United States became a major exporter of crude oil, natural gas, and raw chemicals and plastics. Overall goods exports were up 15 percent by 2019.

The Pandemic Recession

The recession induced by the global response to the pandemic in 2020 reversed much of the gains of the first years of the Trump term, and changed the dynamics of policy in ways that are only beginning to become apparent as the 2020 election approaches. After falling precipitously in the first and second quarters of 2020, manufacturing production was still about 6 percent below year-earlier levels by September. The first three quarters of 2020 saw manufacturing employment sink to levels at the close of the Obama administration. Greater weakness globally relative to the United States resulted in a 17 percent drop in exports of goods in the same period, including 37 percent in the hard-hit commercial aviation sector. Starting in July the sentiment indicators for manufacturing turned positive, and production slowly began to return toward pre-pandemic levels. For example, the auto sector regained 2019 production levels by September and construction in the residential sector was spurred by the dispersion from urban areas. The US Department of Labor reported in October that 460,000 manufacturing jobs went unfilled, due in part to a chronic shortage of trained labor for this sector and to caution by business leaders as the pandemic regained its force in the fall. With the exception of information processing equipment needed for remote work and research and development needed to keep pace with Chinese and other competitors, capital investment remained nearly 10 percent below pre-pandemic levels.

The COVID-19 pandemic has concentrated attention on the long-standing issues of erosion of the domestic industrial base and vulnerabilities due to the fragility of supply chains, especially since the early impact of the disease resulted in interruptions of health care supplies not only from China but also from friends of the United States in Europe and the Pacific Rim. The dependence on China extended beyond personal protective equipment to vital pharmaceuticals and some medical devices and testing equipment. Negative reactions in the United States to Chinese supply disruptions were exacerbated by the aggressive actions by the Chinese Communist Party (at least early in the crisis) to obfuscate the extent of the health issues, and to the willingness of Chinese leadership to exploit the situation by advancing anti-democratic actions in Xinjiang and Hong Kong, and to threaten Indian and Taiwanese democracies. In this environment, the impetus to reverse supply chain leakage to China and move toward greater autonomy was measurably enhanced.

Manufacturing Policy in the 2020 Presidential Campaigns

Despite the vitriolic antagonism between the Trump and Biden campaigns, there is considerable alignment around policies to restore and reshore manufacturing, and to firmly counter the systematic challenge of China to the rules-based global economy. Each candidate vies to outdo the other in how vigorously they would push policies to sanction or otherwise convince China to change its present course. Leading Biden advisors have surprisingly taken the position that foreign policy must in fact prioritize efforts to rebuild the US industrial sector and meet the Chinese mercantilist challenge. For example, Jake Sullivan, distinguished professor of Grand Strategy at Yale University, and Jennifer Harris of the Brookings Institution, argued in an influential article in Foreign Policy that the United States foreign policy establishment should rethink its adherence to “neoliberalism” and put a domestic industrial policy plan at the center of foreign policy:1

Today’s national security experts need to move beyond the prevailing neoliberal economic philosophy of the past 40 years. This philosophy can be summarized as reflexive confidence in competitive markets as the surest route to maximizing both individual liberty and economic growth and a corresponding belief that the role of government is best confined to securing those competitive markets through enforcing property rights, only intervening in the supposedly rare instance of market failure.

They argue that a strong industrial policy and economic stimulus is needed and that not every trade deal is good for the economy and American workers.

This shift in thinking about classical market liberalism, as embedded in the Bretton Woods system, is widely shared in Republican circles as well, and has broad implications for both domestic and trade policy in the United States. Despite wide differences in the scope and depth of commitment to new policies between Republican conservatives such as Marco Rubio and Democratic progressives such as Bernie Sanders, the general trend of US policy is not likely to change dramatically from that of the Trump administration after November 3.

In the most obvious case, trade policy for trade and manufacturing will witness more continuity than change. Efforts to reign in Chinese mercantilist practices, especially in high technology niches important to national security and health care, will continue. Any new trade agreements, such as an accord with the United Kingdom or the possible entry into what is now called the Comprehensive and Progressive Agreement for Trade-Pacific Partnership (CPTPP), would include stronger rules of origin along the lines of the revised NAFTA accord. The Biden team has stressed that they would be more open to cooperation with allies to achieve objectives such as agreeing new WTO disciplines on state owned enterprises and forced technology transfer, or combatting Chinese dominance in third countries over important natural resources such as rare earths, lithium and cobalt. But the campaign statements from both sides are so intransigent on Chinese practices that US trade officials will continue to act unilaterally if allies are not ready to join their initiatives.

The pandemic has also reinforced political convergence in the United States for policies to strengthen the industrial ecosystem. These include macroeconomic measures to increase research and development expenditures, and targeted measures to incentivize and in some cases subsidize specific industries. For example, similar bills have passed both chambers of the US Congress in recent months to provide increased Federal support for basic research, create a national office of technology to coordinate support for industries of the future, support US 5G technology, subsidize the domestic fabrication of semiconductor chips and processing of rare earths, and support local production of vital pharmaceuticals and medical equipment. Some of these initiatives contain policy support and funding for joint work with allies. None of these have yet become law (as Congress has largely stopped work on most issues until the election is past), or, more importantly, been funded. Nonetheless, all enjoy bipartisan support and the backing, for the most part, of the two presidential campaigns. While there is also bipartisan agreement for improving basic infrastructure, including upgrading electrical grids for green power generation and electric vehicles, there is no common approach to finance such a program.

There remain of course wide differences on what specific industrial policies should be pursued and the means to finance them. The Biden team is committed to some version of a “green new deal” and has promised to end electric power generation from fossil fuels by 2035. In the last presidential debate Biden asserted that he would “phase out“ oil production in the United States. California, increasingly claiming the mantle of a harbinger of progressive policy, has declared an end to sales of fossil fuel vehicles by 2015 as well. The temptation of building high speed rail is also a feature of progressive ambition.

Republicans and conservatives still evince considerable reluctance about broadly expanding government funded industrial projects, although, as Congressional action suggests, that reluctance is eroding. Nonetheless, they are more emphatic about using macroeconomic policy to create an environment conducive to growth of industry. Tax policy is central to their approach, and they will fight hard to preserve the 2017 corporate tax reform, which lowered the corporate income tax to OECD-average levels and reinforced deductions and credits favorable to capital investment. The announced Biden tax plan would reverse much of the 2017 changes, all the while arguing that such changes favor domestic reshoring of production.

Republicans, led by Trump, would not support the progressive “green new deal’ especially given the important contributions of new oil and gas production to the industrial revival of the early Trump years, and to the support of labor involved in the extraction and processing of these raw materials. The easing of regulatory burdens on mining and water projects put in place by Trump would likely be reversed or attenuated by a Biden presidency, with potential impact on the distribution of jobs and investment in the economy.

Prospects for 2021 and Beyond

The success of policy choices for an industrial revival for either side will depend on the path of the pandemic and the ability to overcome its damage to employment, business formation and capital investment. Obviously, any revival would also depend on the skillful execution of policy initiatives and not wasting investments on programs with little chance of long- term success, such as high speed rail in the United States.

The fact that China is inexorably pursuing the “China Dream” of greater economic autarky—or decoupling—will in turn spur rivals toward more inward- looking paths.2 This is true not only in the United States but in Europe and Japan as well. Europe, again energized by the realities of vulnerability revealed by the pandemic, and by both Chinese and US policy, is seriously considering new industrial policy characterized as support for its “national champions.” Japan has a more modest—at this point- program to subsidize the return of supply chains to its national territory.

It is worth noting that promoting these variations of inward-looking industrial programs could be very inefficient in terms of economic performance and would help undermine any further efforts to repair the damage to a rules-based system occasioned by Chinese mercantilism. This danger extends to the much-needed coordination of efforts to modernize and reform the WTO. Both the United States and the EU (as well as other like-minded countries) stand to benefit if China moves at least in part toward being a responsible stakeholder, as former World Bank President Robert Zoellick famously phrased the issue.

This author would prefer a more collegial approach to the China challenge then exhibited in recent years by the United States and Europe, or promises to be in the future if the transatlantic partners continue down the path of building their own national champions in the guise of repairing the safety and resilience of their supply chains. The cooperative approach has in the past and will in the future stand a better chance to achieve broadly-shared prosperity, including industrial prosperity, with a more open, market-oriented approach. Effective cooperation ought also to include joint efforts to deny Chinese access to sensitive technologies, which would increase their incentives to come to the WTO reform table. Even if China persists in its current, autarkic path, both the United States and the EU would be better served by industrial cooperation and creating the economies of scale and technological leadership needed to compete successfully with the emerging Chinese economic sphere.