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Archive for the ‘Industrial Policy’ Category

Politicians in Washington very much like the idea of industrial policy.

Steve Forbes, however, warns that legislation to expand cronyism would be a very bad idea.

As Steve notes, politicians foolishly claim we need our own version of industrial policy so we can compete with China’s industrial policy.

But China is suffering in part because of that form of intervention.

So why on earth do American politicians think we should copy the policies of a nation where living standards are only a fraction of U.S. levels?

The bad news, as James Pethokoukis recently observed for the American Enterprise Institute, is that this pork-barrel legislation may soon get through Congress.

…during President Biden’s State of the Union address…he said it was “so important” for Congress to pass something called the “Bipartisan Innovation Act.” To the best of just about anyone’s knowledge, no such legislation existed. Save the “senior moment” wisecracks. Biden was breaking out a new name for a couple of bills making their way through the House and Senate. …few Americans have ever heard of the House’s America Competes Act or the Senate’s U.S. Innovation and Competition Act, despite their huge price tags. But they might want to get up to speed, ASAP. …there’s the substance of the bills themselves, …the parts that seem intent on mimicking top-down Chinese industrial policy, such as the funding for semiconductor manufacturing and efforts to create “Regional Technology and Innovation Hubs” across America.

So what will happen if politicians approved this example of cronyism?

The easy answer is that we will have more politicization of the economy. And that’s not a good outcome.

The Wall Street Journal opined on this legislation last year.

Competition with China will define the coming decades, and Congress wants to get into the game. Alas…the Senate’s nearly 1,500-page Innovation and Competition Act that won’t help innovation or competitiveness. …the bill’s bipartisan support has less to do with China than with its typical Congressional spending blowout and parochial politics. …political strings…always attach to industrial policy. Companies left to their own devices will allocate capital to its most productive use, but government subsidies will steer investment where politics directs. …Many Republicans support the bill because they believe the U.S. needs to mimic Beijing’s directed capital to defeat Beijing. But the U.S. strength has always been its capitalist system, which encourages private investment and innovation through market competition, strong intellectual property rights, and, yes, profits. That’s how the U.S. transcended Japan’s challenge in the 1980s and 1990s. …China’s strategy has long been to subsidize inefficient state-owned enterprises and national champions like Huawei, which has hamstrung smaller potential competitors. …The China challenge requires a better response than the U.S. has mustered to date. But the industrial policy of this bill will waste taxpayer money and divert private capital to less efficient purposes. America can’t out-compete China by imitating it.

Veronique de Rugy also addressed this issue last year.

Here are excerpts from her National Review column.

Industrial policy looks great on paper. The government simply has to identify an industry that needs support, prop it up with subsidies, loans, tax breaks, or protect it from foreign competition with tariffs and other trade regulations, and we will be on our way to fixing many of our problems. …the winners picked by the government may not all turn out to be the champions we hope they will become. …And yet, we continue to believe that somehow, this time, industrial policy will work better. You even hear conservatives make arguments like, “It works in China, so we have to do the same.” It’s as if some people are convinced that the problems that have plagued past and current central-planning efforts in the U.S. government don’t exist in China. But the truth is that China’s successes may not look as good relative to the U.S. if you look closely at the data and facts.

Veronique is right. China is not a role model

Just like the Soviet Union was not a role model.

Just like Japan of the 1980s was not a role model.

Industrial policy has always been a failure, anywhere and everywhere, whether done on a big scale (central planning) or a small scale (business subsidies).

Free markets are the right answer. Though I guess it is not much fun being a politician if your role is to simply leave people alone.

P.S. In his article, Pethokoukis expresses sympathy for having the government fund basic research instead of picking winners and losers. I think he is far too optimistic about getting good results with government-financed research and development.

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It’s hard to be optimistic about Japan’s economic future, in large part because the burden of government is expanding thanks to an aging population and a tax-and-transfer entitlement system.

Maintaining that approach is a recipe for ever-higher taxes (especially since Japan already has record levels of debt).

And Japanese politicians definitely have been grabbing more money, enabled to a considerable extent by a money-grabbing value-added tax.

To make matters worse, the country’s economy has not enjoyed much growth ever since a bubble burst about thirty years ago.

Sadly, the current prime minister, Fumio Kishida, doesn’t seem to have any sensible ideas for his country.

Instead, as reported by Ben Dooley and in the New York Times, he’s latched on to a very silly proposal.

Japan’s prime minister…wants…to…Give…employees a substantial raise. The reasoning is simple. Wage growth has been stagnant for decades in Japan, the wealth gap is widening and the quickest fix is nudging people…to pay their employees more. Higher wages, the thinking goes, will jump-start consumer spending and lift Japan’s sputtering economy. …the prime minister is calling on employers to increase pay as much as 4 percent in 2022. Companies that comply will be allowed to increase their overall corporate tax deductions by up to 40 percent. …Mr. Kishida said…Increasing pay “is not a cost,” he added. “It’s an investment in the future.”

Kishida’s scheme is a bizarre mix of industrial policy and Keynesian economics.

He wants a special loophole in the tax code, but only if companies jump through certain hoops.

All based on the flawed notion that consumer spending drives the economy (it’s actually the economy that drives consumer spending).

Unsurprisingly, the private sector isn’t very impressed by the prime minister’s approach.

Business groups, union leaders and others have questioned the feasibility… That businesses would resist increasing wages even when essentially paid to do so shows just how intractable the problem is. Years of weak growth…have left companies little room to raise prices. …The reaction to the wage proposal is an inauspicious sign for Mr. Kishida, who took office two months ago promising to…put Japan’s economy back on track through a “new capitalism.”

Kishida’s “new capitalism” sounds even worse than some of the gimmicky ideas that have been pushed on the right in the United States (reform conservatism, common-good capitalism, nationalist conservatism, and compassionate conservatism).

From an economic perspective, he needs to learn that sustained higher wages are only possible if there’s more productivity, which translates into more income for both companies and workers.

And that’s not a description of what we find in Japan.

…there is the issue of unprofitability. For nearly a decade, a majority of Japanese businesses have been unprofitable — around 65 percent in 2019, the lowest figure since 2010. They have been kept afloat by cheap money underwritten by the Bank of Japan, but no profits mean no corporate tax liability, so those businesses would not be eligible for Mr. Kishida’s incentives.

The bottom line is that Japan’s political elite has been marching steadily in the wrong direction, and they never seem to learn from previous mistakes.

The government has long tried to find something, anything, to stimulate the economy and push up prices. It has pumped money into financial markets and made borrowing nearly free. But it’s been to little avail…the Japanese government has turned to even larger amounts of stimulus, showering consumers with cash handouts and companies with zero-interest loans. …In 2013, Prime Minister Shinzo Abe introduced a similar plan, with little success. Today, average wages remain stuck at around $2,800 a month, about the same level as two decades ago.

P.S. Part of the problem is that Japanese politicians may be listening to terrible advice from left-leaning bureaucracies such as the International Monetary Fund and Organization for Economic Cooperation and Development.

P.P.S. Here’s another example of a foolish gimmick by Japanese politicians.

P.P.P.S. And let’s not forget that Japan may win a prize for the strangest example of regulation.

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I’ve made the case for capitalism (Part I, Part II, Part III, Part IV, and Part V) and the case against socialism (Part I, Part II, and Part III), while also noting that there’s a separate case to be made against redistribution and the welfare state.

This video hopefully ties together all that analysis.

If you don’t want to spend 10-plus minutes watching the video, I can sum everything up in just two sentences.

  1. Genuine socialism (government ownershipcentral planning, and price controls) is an utter failure and is almost nonexistent today (only in a few basket-case economies like Cuba and North Korea).
  2. The real threat to free enterprise and economic liberty is from redistributionism, the notion that politicians should play Santa Claus and give us a never-ending stream of cradle-to-grave goodies.

For purposes of today’s column, though, I want to focus on a small slice of the presentation (beginning about 2:00).

Here’s the slide from that portion of the video.

I make the all-important point that profits are laudable – but only if they are earned in the free market and not because of bailoutssubsidiesprotectionism, or a tilted playing field.

This is hardly a recent revelation.

I first wrote about this topic back in 2009.

And many other supporters of genuine economic liberty have been making this point for much longer.

Or more recently. In a new article for City Journal, Luigi Zingales emphasizes that being pro-market does not mean being pro-business.

The first time I visited the Grand Canyon many years ago, I was struck…by a sign that said, “Please don’t feed the wild animals.” Underneath was an explanation: you shouldn’t feed them because it’s not good for them. …We should post something of this kind on Capitol Hill as well—with the difference being that the sign would read, “Please don’t feed the businesses.” That’s not because we don’t like business. Quite the opposite: we love business so much that we don’t want to create a situation where business is so dependent on…a system of subsidies, that it is unable to compete and succeed… This is the…difference between being pro-market and being pro-business. If you are pro-business, you like subsidies for businesses; you want to make sure that they make the largest profits possible. If, on the other hand, you are pro-markets, you want to behave like the ranger in the Grand Canyon: …ensuring that markets remain competitive and…preventing businesses from becoming too dependent on a crony system to survive.

Amen.

Cronyism is bad economic policy because government is tilting the playing field and luring people and businesses into making inefficient choices.

But I also despise cronyism because some people mistakenly think it is a feature of free enterprise (particularly the people who incorrectly assume that being pro-market is the same as being pro-business).

The moral of the story is that we should have separation of business and state.

P.S. There’s one other point from Prof. Zingales’ article that deserves attention.

He gives us a definition of capitalism (oops, I mean free enterprise).

We use the term “free markets” so often that we sometimes forget what it actually means. If you look up “free markets” in the dictionary, you might see “an economy operating by free competition,” or better, “an economic market or system in which prices are based on competition among private businesses and not controlled by a government.”

For what it’s worth, I did the same thing for my presentation (which was to the New Economic School in the country of Georgia).

Here’s what I came up with.

By the way, the last bullet point is what economists mean when they say things are “complementary.”

In other words, capital is more valuable when combined with labor and labor is more valuable when combined with capital – as illustrated by this old British cartoon (and it’s the role of entrepreneurs to figure out newer and better ways of combining those two factors of production).

One takeaway from this is that Marx was wrong. Capital doesn’t exploit labor. Capital enriches labor (just as labor enriches capital).

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Long-time readers know that I periodically pour cold water on the notion that China is an economic superstar.

Yes, China did engage in some economic liberalization late last century, and those reforms should be applauded because they were very successful in reducing severe poverty.

But from a big-picture perspective, all that really happened is that China went from terrible policy (Maoist communism) to bad policy (best described as mass cronyism).

Economic Freedom of the World has the best data. According to the latest edition, China’s score for economic liberty rose from a horrible 3.69 in 1990 to 6.21 in 2018.

That’s a big improvement, but that still leaves China in the bottom quartile (ranking #124 in the world). Better than Venezuela (#162), to be sure, but way behind even uncompetitive welfare states such as Greece (#92), France (#58), and Italy (#51).

And I fear China’s score will get even worse in the near future.

Why? Because it seems President Xi is going to impose class-warfare tax increases.

In an article for the Guardian, Phillip Inman shares some of the details.

China’s president has vowed to “adjust excessive incomes” in a warning to the country’s super-rich that the state plans to redistribute wealth… The policy goal comes amid a sweeping push by Beijing to rein in the country’s largest private firms in industries, ranging from technology to education. …Xi…is expected to expand wealth taxes and raise income tax rates… Some reforms could be far reaching, including higher taxes on capital gains, inheritance and property. Higher public sector wages are also expected to be part of the package.

And here are some excerpts from a report by Jane Li for Quartz.

Chinese president Xi Jinping yesterday sent a stark message to the country’s wealthy: It is time to redistribute their excessive fortunes. …Another reason for the Party’s focus on outsize wealth is to reduce rival centers of power and influence in China, which has also been an impetus for its crackdown on the tech sector… China already has fairly high income tax rates for its wealthiest. That includes a top income tax rate of 45% for those who earn more than 960,000 yuan ($150,000) a year… Upcoming moves could include…a nationwide property tax.

These stories may warm the hearts of Joe Biden and Bernie Sanders, but they help to explain why I’m not optimistic about China’s economy.

If you review the Economic Freedom of the World data, you find that China is especially bad on fiscal policy (“size of government”), ranking #153.

That’s worse than China does even on regulation.

Yet the Chinese government is now going to impose higher taxes to fund even bigger government?!?

Is the goal to be even worse than Venezuela and Zimbabwe?

P.S. Many wealthy people in China (maybe even most of them) achieved their high incomes thanks to government favoritism, so there’s a very strong argument that their riches are undeserved. But the best policy response is getting rid of industrial policy rather than imposing tax increases that will hit both good rich people and bad rich people.

P.P.S. I’ve criticized both the OECD and IMF for advocating higher taxes in China. A few readers have sent emails asking whether those international bureaucracies might be deliberately trying to sabotage China’s economy and thus preserve the dominance of Europe and the United States. Given the wretched track records of the OECD and IMF, I think it’s far more likely that the bureaucrats from those organizations sincerely support those bad policies (especially since they get tax-free salaries and are sheltered from the negative consequences).

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China is not going to surpass the United States as the world’s dominant economy.

As I first wrote back in 2010, China is a paper tiger. Yes, there was some pro-market reform last century, which helped reduce mass poverty, but China only took modest steps in the right direction.

According to the latest edition of Economic Freedom of the World, China scores just 6.21, which places it 124th out of 162 nations.

Is that better than a score of 3.69, which is where China was in 1990?

Yes, of course.

But does that score indicate that China will become richer than the United States, which has a current score of 8.22 (the world’s 6th-highest level of economic liberty)?

Of course not.

My answer might change of China engaged in more economic liberalization, as I have urged. But it seems the opposite is happening and China is backsliding toward more state control.

And that means the United States almost surely will remain far more prosperous.

(While Joe Biden is doing his best to drag economic policy in the wrong direction, but it would takes decades of far-worse policy to bring the U.S. down to the level of France (#58) or Greece (#92), much less all the way down to being on par with China).

But some people must not be very familiar with data about China and its economy.

For instance, President Trump’s former top trade official, Robert Lighthizer, wrote that the United States should copy China’s cronyism in a column in the New York Times.

I’m not joking. Mr. Lighthizer openly embraces industrial policy and protectionism.

…we need a multifaceted long-term strategy. …Our strategy must include…an industrial policy that includes subsidies to foster the development of the most advanced science and technology…and a robust plan to combat China’s unfair trade practices. …The Senate legislation would achieve some of what is needed. It calls for $200 billion to bolster scientific and technological innovation, $52 billion to rebuild our capacity to make semiconductors, and a supply-chain resiliency program… The House should perfect the provisions of the Senate bill that restructure and enhance federal support for science and innovation and strip out those that weaken our trade laws and encourage Chinese imports.

Geesh, no wonder Trump’s trade policy was such a disaster.

Lighthizer not only doesn’t understand economics, he also doesn’t know history.

Adam Thierer of the Mercatus Center points out that the current angst about China is a repeat verse of a song we heard over and over again in the late 1980s.

Back then, everyone though Japan was on the verge of overtaking the United States, ostensibly because that nation had wise politicians and bureaucrats who knew how to pick winners and losers.

Thierer’s article tells us what really happened.

In 1949, the Japanese government created the Ministry of International Trade and Industry (MITI) to work with other government bodies (especially the Bank of Japan) to devise plans for industrial sectors in which they hoped to make advances. Although not as heavy-handed as Chinese planning authorities are today, MITI came to have enormous influence over private-sector research and investment decisions during the next five decades. The organization used a variety of the same policy levers that Chinese officials do today, with a particular focus on trade management and industrial policy investments in sectors perceived to be “strategic” for future economic advance. …By the late 1970s…, U.S. officials and market analysts came to view MITI with a combination of reverence and revulsion, believing that it had concocted an industrial policy cocktail that was fueling Japan’s success at the expense of American companies and interests. …By the end of the 1980s, fears about “Japan Inc.” had reached a fever pitch. …Just as Japan phobia was reaching its zenith in the early 1990s, Japan’s fortunes began taking a turn for the worse. The Japanese stock market crashed in 1990… Japan suffered a brutal economic downturn that became known as the Lost Decade, which really lasted almost two decades. …by the late 1990s many scholars came to view most Japanese industrial policy initiatives as a costly bust.

Amen.

I wrote that Japan was a “basket case” back in 2013. A bit of hyperbole, to be sure, but I was trying to drive home the point that the nation’s politicians have made some costly mistakes.

Not just industrial policy, but also tax increases, Keynesian spending, and other forms of intervention.

No wonder the country has gone downhill in terms of competitiveness.

But let’s not focus too much on Japan (which, despite all my grousing, still ranks #20 for economic liberty).

For purposes of today’s column, the main points are 1) that China is no threat to overtake the United States, and 2) that copying that nation’s industrial policy would be a mistake.

P.S. If China wants to pursue industrial policy and other forms of cronyism, that’s a mistake that mostly hurts the Chinese people. To the extent such policies are designed to subsidize exports (as Lighthizer argues), the best response is to utilize the World Trade Organization, not to copy China’s misguided interventionism.

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Politicians often support “industrial policy,” which means they get to grant special favors to well-connected companies or industries.

But as explained by Professor Burton Folsom, this approach didn’t work very will in the 1800s.

It’s not surprising, of course, that politicians like having the power to grant favors. It makes them feel important.

But such policies don’t work. At least if our measure of success includes things like competitiveness and efficiency. Or of if we care about the best interests of consumers and taxpayers.

Which is why is better to be on the correct side of this spectrum. In other words, as far from Soviet-style central planning as possible (I used to cite Hong Kong as an example of laissez-faire, but that may no longer be accurate).

By the way, the video also makes a good point about how the United States was not a laissez-faire paradise back in the 1800s.

While we didn’t have an income tax or a welfare state, there were other forms of intervention, as illustrated by the video, as well as lots of protectionism and regulation.

And don’t forget slavery, which was an especially grotesque anti-market policy.

The bottom line is that only politicians benefit when government has more power over the economy.

For the rest of us, the lesson to be learned is that government intervention doesn’t work. Not in the 1800s. Not in the 1900s. And not in this century, either.

If we want more prosperity, we should stick with the tried-and-true recipe for growth.

P.S. Professor Folsom also narrated a video showing how government intervention failed in the 1800s (railroads) and early 1900s (airplanes).

P.P.S. It’s especially disappointing that some self-styled conservatives are supporting industrial policy since – in practice – it means awful policies like Solyndra-style handouts and power-grab schemes like the Green New Deal.

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If you want to understand how government really works, learn about “public choice.”

This is the common-sense theory that politicians and other people in politics often make decisions based on self interest, and it does a very good job of explaining why we get so many short-sighted and misguided policies from the crowd in Washington.

Public choice is especially insightful when compared to the naive view that politicians are mostly concerned with helping ordinary people.

The theory also tends to generate some pithy concepts, such as “stationary bandit” and “predatory government.”

Another example is “grabbing hand,” which describes how intervention usually is a vehicle for helping government rather than helping people.

Today’s column is going to be about industrial policy (the incrementalist version of central planning) as an example of this phenomenon.

Specifically, we’re going to look at a new academic study that measured the impact of government control on the performance of companies in China.

Written by Marzieh Abolhassani, Zhi Wang, and Jakob de Haan, it’s a test of whether government is a “helping hand” or “grabbing hand.”

We’ll start with their description of the study’s methodology.

…the impact of government involvement on the financial performance of listed firms in emerging economies has received scant attention. This paper examines the relationship between government control of firms and firms’ financial performance for the case of China. …we measure government control by the fraction of outstanding shares held either directly or indirectly by the government. …We classify firms as state controlled whenever the government is the shareholder with the largest number of shares held either directly or indirectly through pyramid structures.

Here are the key results.

Our empirical results suggest that firm performance is generally lower for firms where the government is the shareholder with the largest number of (direct and indirect) shares. Specifically, the return on assets, the return on equity and the market-to-book ratio are, on average, 1.3%, 2.0% and 8.2% lower for government-controlled firms. Both central and local government control is undermining firm performance. These findings provide support for the ‘grabbing hand’ theory of the government. … we make sure the estimates are not driven by differences in the size, age and leverage of the firms. Importantly, we also control for industry-region-year fixed effects, and therefore compare firms within the same industry in the same province during the same year, further enhancing the credibility of our estimates. …These results provide support for hypothesis and to theories conjecturing that management of firms controlled by the government have fewer incentives to maximize profits and shareholder value.

For those who like the wonky details, here are the key findings from their number crunching.

So what’s the bottom line?

Their conclusion tells us everything we need to know.

The results reported in this study broaden our understanding of the role of government influence on firm performance. …Our empirical results indicate that government-controlled firms have a worse financial performance than non-government-controlled firms. …These conclusions support the ‘grabbing hand’ theory proposed by Shleifer and Vishny.

So why do these results matter?

From an economic perspective, it’s further evidence that government intervention leads to a misallocation of resources. And that inevitably means living standards will be lower than they would be if markets were allowed to function.

A recent article from Foreign Affairs suggests enormous potential benefits if China ended industrial policy.

…state-owned enterprises… These inefficient behemoths control nearly $30 trillion in assets and consume roughly 80 percent of the country’s available bank credit, but they contribute only between 23 and 28 percent of GDP. …The economist Nicholas Lardy has estimated that genuine economic reforms, in particular those targeting state-owned enterprises, could boost China’s annual GDP growth by as much as two percentage points in the coming decade.

Very similar to what I’ve written, so let’s hope that China returns to the policy of economic liberalization that led to genuine progress.

I’ll close with the depressing observation that there are people in Washington who are now agitating for industrial policy in the United States.

Needless to say, there’s zero reason to think that intervention from Washington will produce results that are better than intervention from Beijing.

P.S. It doesn’t matter if Republicans are trying to pick winners or Democrats are trying to pick winners. When politicians intervene, the economy suffers, which means less prosperity for ordinary people.

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