June 17, 2019

Elizabeth Warren wants an industrial policy. Here are the traps to avoid.



In a new campaign proposal for reviving American manufacturing, Sen. Elizabeth Warren (D-MA) argues that American companies have recklessly offshored industry, prioritizing shareholders at the expense of working- and middle-class jobs. To address this situation, she calls for aggressive interventions that include:

  • Weakening the U.S. dollar to spur export industries;
  • Expanding publicly funded R&D;
  • Requiring the government to purchase American-made products;
  • Investing in postsecondary apprenticeship programs;
  • and creating a “Department of Economic Development” to coordinate trade- and development-related agencies around a National Jobs Strategy.

Warren cites the experiences of Germany, Japan, and China as countries that have had success with industrial policies America is allegedly too timid and constrained to pursue. “If we want faster growth, stronger American industry, and more good American jobs,” she writes, “then our government should do what other leading nations do and act aggressively to achieve those goals instead of catering to the financial interests of companies with no particular allegiance to America.”

Sen. Warren’s proposal comes at a time when “industrial policy” — once a term of derision — is gaining plaudits among commentators and academics alike. But enthusiasm for what Warren calls “economic patriotism” must be tempered by careful analysis of the specific policies being proposed. In what follows, I take a closer look at the tools other rich countries have used to develop and sustain globally competitive manufacturing industries, and gauge their applicability in the U.S. context.

The Case for Export Discipline

The common thread in Warren’s proposal is the notion that increasing exports can raise national productivity and thereby create higher-quality jobs. The growth miracles in Japan, Korea, and Taiwan, for example, were all driven by export-oriented manufacturing growth, as well as policies designed to nurture infant industries and climb the technological learning-curve. “How Asia Works,” by economic journalist Joe Studwell, documents the success of this growth model. But in contrast to traditional mercantilist theories based on the intrinsic value of a trade surplus, Studwell argues export-oriented growth mainly worked because of a concept known as “export discipline.”

The international market is inherently more competitive than local markets, given its scale and the number of competitors involved. Export-oriented firms are therefore always on their toes to find ways of improving their productivity, including the adoption of superior technology and processes. Export discipline refers to this heightened degree of “survival of the fittest,” which East Asian governments used to their advantage, separating the wheat from the chaff and accelerating the process of creative destruction.

Export discipline means that the government doesn’t have to pick winners — the market does it for them. On the contrary, successful industrial policy prioritizes cutting out the losers, enabling scarce capital and talent to reallocate from floundering firms to successful ones more quickly. For better or worse, this can lead to industry consolidation, as in the case of Korea’s large conglomerates. But as market concentration goes up, investments in R&D and scaled-up coordination permit the emergence of new technologies, as Michael Lind and Robert D. Atkinson have argued. Successful industrial policy is thus in tension with Sen. Warren’s hopes for stronger antitrust enforcement. Indeed, growing domestic industry concentration is often an efficient response to a more globalized economy.

The International Experience

To understand the power of export discipline, consider China. At first, the country’s lower-wage labor allowed it to rapidly scale up labor-intensive manufacturing. But over time, China rewarded firms that compete internationally, encouraged the diffusion of (sometimes pilfered) technologies across firms, and scaled up to far more technically complex products. Their catch-up growth in the telecom industry provides a case in point. While China’s telecom giant Huawei has provoked controversy in developed markets today, it was the result of China carefully allowing Western firms like Alcatel into the country. By studying foreign-made components, China’s domestic firms quickly perfected simpler components such as telephone switches before moving up the product chain. The end result was the formation of the largest network service provider in the world.

China also offers a lesson in the ineffectiveness of success-neutral incentives. In 1985, the Chinese government implemented a duty drawback program that effectively lowered tariffs on imported inputs used for manufacturing exports. The theory was that rewarding production inputs with refunded duties would benefit the firms exporting the most. But the policy had no effect in generating greater competitiveness among exporting firms, possibly due to false reporting by manufacturing firms trying to game the system.

The importance of export discipline isn’t limited to the developing world. A close analysis of manufacturing firms in the United Kingdom, for example, found that trade rewards higher-productivity firms, boosting aggregate productivity. The mechanism behind this finding is not that exports directly raise productivity (although “learning by exporting” does take place). Instead, high-productivity firms self-select into export markets, while less competitive firms wither on the vine. Genuine productivity growth requires those firms to shut down and for their resources to move either into superior firms or into other industries. In this sense, the worst consequences of the China Shock for the U.S. manufacturing sector were caused less by the shock itself, and more by our failure to effectively transition the displaced workers and capital into higher-value sectors.

Export Discipline, Not Protectionism

The international experience with export promotion illustrates the fallacy behind both President Trump’s tariff-based approach to salvaging American industries and Warren’s proposal to strengthen “Buy American” rules for public procurement. While industrial policy is often conflated with protectionism, in some ways it’s the opposite. Rather than shielding U.S. companies from foreign competition, export discipline would work by thrusting domestic firms into the international sphere of cutthroat capitalism, with a strategy for aggressively upgrading or transitioning the companies and workers that get left behind. By largely failing on that latter imperative, the United States has only captured a fraction of the full benefits to trade liberalization.

Blocking imports and promoting exports may seem like mirror images of each other, but they have very different implications. Israel, for example, has extensively leveraged export credits to encourage firms to develop internationally competitive manufactured goods, and for its efforts it has been labeled the “Startup Nation” by some analysts. The United States offers similar support through its Export-Import Bank, which Warren’s proposal would greatly expand. Unfortunately, Ex-Im largely functions as corporate welfare for large incumbents like Boeing, rather than as a tool for creating upstart exporters in the wake of global competition. Perhaps Ex-Im can be reformed, but until that point, new export promotion programs are likely better housed in a less captured agency.

If we are to adopt policies based on export promotion, inefficient and less competitive firms must not receive the same rewards as competitive ones, and the administering agencies must have the capacity to cut off rewards to firms once they have matured. Mandating all government purchases go to American firms, in contrast, would merely inflate fiscal costs while privileging domestic producers regardless of their performance.

Senator Warren’s proposal for “economic patriotism” has brought an important issue to the 2020 campaign. But even if it gets the broader themes right, its specific policies must be scrutinized in accordance with our existing knowledge of how manufacturing- and export-oriented development works. As the Democratic primary continues to develop, hopefully a more fruitful discussion will arise about how to restore American manufacturing without turning inward — a dual imperative that our current president has failed to understand.