Industrial Policy 101
A Q&A with Scott Lincicome on the Problem with Picking Winners & Losers
We’ve been hearing about the end of globalization for the better part of the last decade, and yet rumors of its demise appear to have been greatly exaggerated. The latest calls for American energy independence and re-shoring manufacturing are part of this broader trend, which seeks to insulate the domestic economy from turmoil in faraway regions. COVID-19 also brought the idea of “industrial policy” back to the forefront. While it’s hard to pin down an exact definition, Scott Lincicome of the Cato Institute relates some key features behind the misguided notion that the government must steer critical industries for reasons of national importance.
Whether we’re talking about steel, oil, or semi-conductors, the proponents of a robust industrial policy argue that we’ve become too reliant on our potential foes for strategic resources, and must set national production goals through legislation rather than impartial market forces. This can range from Soviet-style central planning (which led to the ultimate collapse of the USSR), to the use of trade barriers, tax incentives and subsidies — i.e., “picking winners and losers.”
Even with the latter approach, Lincicome points out many flaws in modern American industrial policy. In a recent Cato white paper, Questioning Industrial Policy he highlights the inefficiencies brought about by injecting politics into the market’s discovery process, and notes how most recent attempts to “improve” the outcomes of global competition have tended to hinder even our vital domestic industries.
Scott joined me to break down the report, and make the case for embracing globalization and free trade in the 21st century rather than hunkering down in our domestic silo.
Listen or ready the summary below:
What is Industrial Policy?
SCOTT: In the simplest sense, industrial policy is the government picking winners and losers in the market. Specifically, throughout the history of the United States, it has been about boosting manufacturing – not services or agriculture.
Next, it’s about targeted and directed micro-economic support as opposed to horizontal, sector-wide or economy wide policies. For example, we impose tariffs to protect the steel industry, as opposed eliminating corporate taxes.
Third, the government is trying to correct market falures like negative externalities or a shortage of investing in manufacturing to achieve more jobs or output in the steel industry.
The government is trying to beat the market.
BOB: As a more modern example, Scott cites the example of subsidizing solar panels to achieve a national climate strategy. We all remember what happened with Solyndra – a cautionary tale against picking winners and losers.
In Rush to Assist a Solar Company, U.S. Missed Signs (Published 2011)
When governent “picks” winners, it first takes money away from individual citizens – disenfranchising us of our right to “Vote with Our Dollars.” This market voting mechanism is how we collectively decide what products should be produced.
What distortions result from the government depriving us of this right to vote economically?
SCOTT: There is a huge knowledge obstacle in industrial policy. F. A. Hayek noted that a single central planner lacks the knowledge to implement some grand economic plan because the plan lacks the decentralized decision-making that is the market process, which involves millions of us acting in a mostly self-interested way. Yet we collectively are very wise and tend to pick the right stuff to produce, and to pursue the most productive and innovative products and services to our own benefit and to society’s benefit.
It’s impossible for any small group of people to know precisely what is going to be the next big company that will produce that innovation we want.
We saw this lack of knowledge on display in the ‘90s with the alleged shortage of semi-conductors:
SCOTT: We thought we had to protect American DRAM producers from Japanese producers, but it turned out that Japan was not the threat, it was South Korea, which we actually helped to grow. We even picked the wrong product. Companies were innovating away from memory chips. They were not going to be the future of the industry — they were moving to logic chips.
Especially in the high tech area, you see the government just simply cannot surmount the knowledge problems.
The Industrial Policy Grift
Beyond this knowledge problem, there is the problem of a sluggish political process that cannot respond quickly enough to market demands to “beat the market” in fast-moving industries like semi-conductors. Apparently, no one learned the lessons of the ‘90s, because politicians are again promoting protectionist industrial policy in the face of chip shortages. Scott tells the sordid tale of expanding price tags and diminishing expectations:
SCOTT: They added several billion dollars — not for the newest, most innovative chips, but for old chips. Why? Well, because automotive manufacturers like and need these old chips. So the Michigan Senators acted to the benefit of the auto industry and we got this behemoth bill.
Of course, the crisis is over, but we’re still probably going to pass it anyway, because once these trains kind of get going, it’s very, very hard to stop.
Speaking of trains, I’m reminded me of the ill-fated “High-Speed Rail” project in California, which was supposed to go from SF <->LA, but instead ran way over budget even after downgrading its expectations from high speed to conventional rail, and altering it’s route to Merced<-> Bakersfield.
Governor, legislators won't budge in high-speed rail dispute
We see industrial policy benefitting the few at the expense of the many over and over — the direct result of influence by rent seekers. They dress their arguments in the language of “market failure,” but oftentimes the special interests are the only ones whom the market is failing to satisfy. Lincicome acknowledges that market failures do exist, such as air pollution, but the political solutions tend to be based on short-term thinking — neglecting the fact that markets constantly adapt and often fix externalities faster and more cheaply than government.
Examples of Industrial Policy
To see how this looks in the real world, what are some examples of failed Industrial Policy?
SCOTT: During the Obama administration the Department of Energy funded a lot of carbon capture projects by subsidies. Carbon capture can be a perfectly legitimate innovation to address carbon emissions and the rest. The problem was that the projects picked tended to be far more about politics than about actual scientific innovation.
[There] was a huge carbon capture project in Illinois (which just so happened to be President Obama’s home state), that he promised would receive government funds while on the campaign trail back in 2008. Another big project went to Ethanol producers, who lobbied heavily.
Ethanol comes from corn. Ethanol = Iowa = The First Primary. Ethanol subsidies are a terrible policy, promoting a terrible product, but one that sticks around forever, Lincicome notes, because of the political dimension. There was also a close connection between the projects selected for renewable energy loans and grants, and those that spent money on lobbying.
SCOTT: Contracts actually did not go to small startups that might need the government’s help to get going. They went to big established corporations that spent tons of money to win these contracts and win the subsidies.
Programs are often modified… to satisfy politically-connected. Over time, agencies that were started to benefit the public become captured by the industries that they’re trying to regulate. They become de facto arms of the industry itself.
The Department of Commerce is effectively part of the steel industry.
Our maritime regulator is effectively an arm of our ship building sector, which benefits from the Jones Act, which restricts domestic shipping to American made ships.
How Consumers are Hurt
It’s one thing to see how industrial policy harms the unprotected competitors in a given industry, but another to see how this effects us as consumers, aka “voters” with our dollars. Scott gives three examples:
Investments in renewable energy — Big loan programs in 2009–2010 crowded out priate investment in the sector. The companies that weren’t connected politically couldn’t get capital and ended up going bankrupt.
Trump’s 25% steel tariffs — This involuntary transfer of dollars from steel consumers (manufacturers) to domestic steel producers costs you and me, because the costs are passed on. United Steelworkers Union lobbied heavily for these tariffs, which make it impossible for U.S. companies to purchase less expensive foreign steel.
Jones Act shipping restrictions — Restrictions on foreign ships act as an effective blockade on trade between different places within the U.S. like Puerto Rico, Hawaii and Alaska, which are cut off from Highways and rail. The Jones Act increases prices in Puero Rico, delivering windfall profits to the domestic shipping industry. Puerto Rico buys its gas from Russia instead of the U.S.
The “Buy American” Fallacy
“Buy American” is a cornerstone of industrial policy, and an epitome of its failures. Lincicome explain the concept and the fallacy behind this slogan:
SCOTT: When we want to build a highway with federal dollars, you have to use American steel, for example.
Now, even Milton Friedman and Adam Smith acknowledged that free trade principles can have exceptions for national security. In times of war, we may want to restrict imports. In practice, however, it’s always the government’s excuse.
Trump’s own secretary of defense, General James Mattis, wrote a letter saying the Defense Department only needs 3% of all U.S. steel production for national defense.
Trump of course ignored that and imposed global tariffs.
Lincicome notes that diversity of supply helps with national security, whenever there is a large economic shock, such as what we’re seeing with baby formula.
SCOTT: It turns out the baby formula market in the United States is highly protected. There is essentially a tariff and regulatory wall around the United States, such that U.S. baby formula manufacturers represent about 98% of all sales in the United States.
We had a big recall at a manufacturing facility in Michigan, and because we have no alternative suppliers outside of the country, the U.S. market is collapsing right now. Shelves store shelves are empty. Moms are freaking out. That’s because we don’t have a diverse supplier base.
As a business person with such amazing insight into American business, I have observed that it is bad for business to kill your customers. That’s not the way to build market share. Thus, trade with other countries makes them likely to want to kill you, because you’re too good a customer. Not only do tariffs increase costs on me the consumer, but limiting free trade also violates my economic rights to buy from whomever I want.
Finally, Scott notes that the “deadweight loss” resulting from protectionist policies decreases the dynamism of the economy and makes our domestic industries more bloated — less competitive. By “
buying American, we insulate our firms from the market forces that make them stronger and more innovative.
SCOTT:The ultimate example of this for those like me is to compare American automobiles in the early 1980s or late 1970s to automobiles today. The difference is just astounding. We were making garbage vehicles here until Japanese and German competition came along, when suddenly the Big Three had to get their act together. Now, the quality standards are just about as good as the foreign brands.