Howard W. French
For more than a decade, I have taught classes that try to cast light on the enormous challenges that so-called developing countries face as they seek to raise the standard of living of their people and hopefully become prosperous.
The fact is that, since the end of World War II, very few non-Western societies have joined the restricted circle of rich countries; so few of those nations are large ones that with little practice, one can easily reel off most of their names: Japan, South Korea, and for obvious special reasons, a handful of oil-rich states in the Middle East.
Across this time span, most of the world’s population has remained stuck with low per capita income or absolute poverty, with little obvious prospect of ever climbing out of this station. Members of another group of countries have enjoyed periods of remarkable economic advancement before regressing or just running in place, never quite making it to the dreamed-of winner’s circle, which one might think of as a virtual continent composed exclusively of countries whose citizens enjoy high average per capita income.
These countries are commonly said to be stuck in a so-called middle-income trap—and as disparate as they may at first seem, whether Brazil and the Soviet Union in the 1960s or (for many) China today, certain elements of their trajectories and of the strategies they have employed to sustain high growth have so much in common that they bear a close look as a group.
To launch their high-growth phases, most of these middle-income countries invested surpluses from agricultural exports in developing manufacturing. In an earlier age, this might have been textiles or processed foodstuffs. More recently, countries such as China launched their industrialization by focusing on relatively easy-to-master things like toy manufacturing using injection plastics or simple assembly processes, say, with basic electronics.
As the diversity of their manufacturing began to broaden and grow more sophisticated, many middle-income countries began protecting their domestic markets against imports from richer and more highly industrialized societies. The idea behind this is intuitive enough: Success at home seems like a necessary first step and a springboard toward international success.
As they raised barriers to protect their home markets, these countries often sought to attract foreign investment and technology to rise up the industrial chain or ladder and to produce more and more complex goods, with ever higher value added as well as profit. In pursuit of this goal, many of these governments channeled their own investments into priority industries while providing them with all sorts of other non-financial assistance, from free or subsidized land to deep tax discounts. With China, this worked so well that the country went from manufacturing half as much as the United States in 2002 to manufacturing twice as much today.
What has been described thus far is a highly abbreviated version of the foundations of what is commonly known as industrial policy, and strategies like these have worked very well in the initial stages of economic takeoff in numerous places but with striking infrequency in the longer run. As someone who writes often about the challenges facing the developing world, and about Africa in particular, I have a deep interest in exploring the reasons, both strategic and structural, for why the road to prosperity is so difficult for the majority of the world’s countries.
This column is about something altogether different though: raising what I hope can be understood as sensible cautions about accelerating efforts by the United States to use industrial policy to sustain its own economic advancement, stave off further relative industrial decline, and retain an edge in its competition with China.
Ironically, it is China itself that provides some of the best examples of what can go wrong with industrial policy. In funneling capital and providing other advantages to industry, the Chinese economy has grown addicted to investment. What this means is that it takes China the commitment of ever more new capital in the form of investment just to maintain a given growth rate.
All the while, the return on that investment has steadily decreased. In the early stages of China’s takeoff, it might have required only $1 of investment, for example, to produce $3 of growth. Over time, however, the bang for that invested buck has declined, from $3 of growth to $2, then from $2 to $1, and finally reaching a situation where it might take more than $1 of investment to produce a dollar of new growth. This is called a negative return.
Just as alarmingly for China, the country’s productivity growth has also turned negative. This means the speed with which the output per worker is growing is actually in decline—despite the constant introduction of new technologies.
I have thought about all of this as I have watched the Biden administration’s ambitious CHIPS and Science Act take form. It aims to reshore high-end microchip manufacturing to the United States with $53 billion in government investment and other types of public support.
I am neither an economist nor a soothsayer, and this should not be read as a prediction that the CHIPS and Science Act will fail. It is, however, a statement that for something so large, its strategy and provisions feel underexamined—and, in particular, that not enough attention has been paid to understanding the experience of China, the country that the law is explicitly intended to outcompete. That is because China has become an almost magic word in U.S. political discourse. Brandish it loudly enough nowadays, and it seems like one can bulldoze almost anything through the logjams that Congress traditionally throws up, whether sensible or unwise.
For all of its general success in rising to the status of the world’s largest or second-largest economy (depending on what measuring stick one uses) and in raising average per capita GDP to the level of a high middle-income nation, China has had very mediocre results in identifying the most important frontiers of economic activity for the future and then through state investment and other support create so-called national champions in those fields.
Two examples suffice. The first is commercial aviation, a sector that Beijing has invested in enormously, dating from before the time I worked in China as a correspondent in the early 2000s, yet still with little prospect of having a viable competitor for Boeing, Airbus, or even a number of smaller airline producers for the international market. Incidentally, Japan, too—long a believer in industrial policy—has recently thrown in the towel on competing with the established giants after spending hugely on its own bid to become a major airliner manufacturer.
The other showcase example here ironically involves microprocessors. Far from becoming a world beater, China’s big, would-be national champion, Tsinghua Unigroup, has flirted with bankruptcy, requiring ever more support from the state.
Why do efforts like these so often fail to pay off? A traditional answer, not without a solid basis in logic, is that governments and bureaucrats are poor at assessing both the complexity of markets and rapidly changing technology horizons. This is true enough, but there are many other factors involved.
Perhaps most importantly, unlike businesspeople who must raise capital privately, those who formulate and execute grand industrial policies using public money don’t risk losing their shirts. That danger is an incredible tonic, and we haven’t figured out how to replace it. The politicians and bureaucrats will shuffle off the scene, facing no economic penalty or even reputational damage for their failed bets. But there is worse still.
Governments, unlike private businesses operating on their own, are almost endlessly prone to throwing good money after bad. When the initial projections of the microchip or airliner breakthrough don’t pan out, there is always someone to say, “Just give it some more time, and some more money too”—someone else’s money.
Powerful constituencies build up around these ventures, and they acquire a force of their own. How do you cut your losses on the new chip fab that isn’t panning out or the airline assembly plant that can’t make it on its own in the market, when it employs, say, 200,000 workers and an entire regional economy depends on it? This is a problem as insoluble in an authoritarian state like China as it is in a democratic one like the United States. Politicians go to bat for their constituents, and the subsidies become almost impossible to shut off. Here, U.S. defense procurement offers a wealth of examples of weapons systems that the Defense Department no longer wants but which members of Congress insist on continuing to produce.
None of what I have written here should be construed as being ideologically based. I am about as far as one can get from being a free market fundamentalist. I have spent more of my time wondering, in fact, if there are any true free markets. Taken in the abstract, the idea of ensuring competitiveness in an area like microchips strikes me as appealing enough. Its national security implications seem obvious to me. Now is the time, though, to have utter clarity about the real economics involved—not after the country is up to its ears in sunken costs.
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