The West Fights Back!
After decades of using its influence at institutions like the World Bank and the IMF to influence governments around the world to cut back on tariffs and subsidies and embrace free trade, the United States has in recent years launched the most sweeping industrial policy in generations. This is a big change. [Reagan Clip] Forty years after Ronald Reagan rejected large-scale government intervention in the economy and thirty years after Bill Clinton signed the Nafta free trade agreement, US politicians have been pushing through tariffs on foreign goods and subsidies for domestic producers in strategic sectors, with the hope of boosting the US economy, reinvigorating the manufacturing sector and creating new jobs. Obviously, a big reason for this change in direction has been competition from countries like China whose planned economies have seen great success over the last twenty years. But does that really mean that heavy handed government intervention is the right direction for western economies to move in? Industrial policy is a term for a set of policies that governments use to bolster national industries or companies deemed strategically important for either economic competitiveness, social outcomes, or national security.
Washington’s new embrace of industrial policy has made other advanced economies nervous. They worry about the competitive threat of subsidized American companies and the risk of seeing some of their industrial base migrate to the United States. Afterall, US Congress has enacted hundreds of billions of dollars of subsidies for semiconductors, renewable energy and infrastructure. President Biden, like President Trump before him, has used tariffs, export controls and “buy American” policies to strengthen domestic industries and counter competition from China.
Many of the new programs are focused on businesses that assemble products in the United States. This encourages international companies to move production to America. If they do this, not only do they qualify for the massive subsidies on offer from the Biden administration — they can also benefit from lower US energy costs and lower taxes. The reaction of other advanced economies to this change has shifted from surprise to a search for ways to catch up and compete in this new trade environment. The EU, Japan and South Korea have all introduced subsidies of their own for their tech and clean energy sectors, to attract new investment or prevent more companies from migrating to the United States. Europe, in particular, has jumped on the bandwagon by setting aside €160 billion euros of its pandemic recovery fund for digital innovations such as computer chips, batteries, and climate adaptation.
Japan is providing subsidies worth more than $500 million dollars to 57 companies to encourage them to invest domestically—as part of its efforts to reduce reliance on China. So, what has led the world in this direction, and does this strategy make sense? Before digging into to that, let me tell you about today’s video sponsor Incogni. Every year the absolute number and the scale of data breaches worldwide are rising. According to the 2022 Annual Data Breach Report by the Identity Theft Resource Center, the number of victims has gone up nearly 41.5% from 2021. Data brokers collect your personal information including your name, Social Security Number, location, online activity, and much more.
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Sign up for Incogni by using the link in the description below. The first 100 people to use the discount code PATRICK will get 60% off of Incogni Western governments in their fight against climate change have all signed up for expensive ESG policies. They signed the Paris Climate Accords which involve cutting emissions by roughly 50% before 2030. This means that they are trying to transition to green energy sources like solar and wind and move to using mostly electric vehicles at quite an accelerated pace. China leads the supply chains for all of these goods, which means that Western economies find themselves at Chinas mercy. The new industrial policies being put in place aim at competing in these specific industries through fighting subsidies with subsidies.
For all of the talk about competing with China, the US and Europe are dwarfed in cleantech manufacturing by China. On top of this, almost all of the critical minerals and parts needed for green technology are sourced or processed in China. China accounted for 70% of world mine production of rare earths in 2022 and is home to 85% of the world's capacity to process rare earth ores into material manufacturers can use.
In other parts of the world environmental standards make entering this industry extremely difficult. In solar power, US efforts to limit China’s presence in supply chains has already proven quite difficult. Last year the Commerce Department launched an investigation into tariff-dodging by Chinese suppliers. But when this led to a drop in US solar installations, the White House decided to suspend the investigation. What the US sees as a strategy to reverse the loss of its manufacturing industry, reduce its dependency on imported goods, and compete in the cleantech industry, historic allies have interpreted as protectionism.
There have been calls in Europe to retaliate against the United States with similar protectionist policies as the Inflation Reduction Act or to file a complaint with the WTO. The world is moving in a strange direction when every government plans on taxing its citizens to subsidize the manufacturing of goods so that they can fight off foreign competition. But that is where we seem to be right now. Americas loss of faith in laissez faire economic policies can be partially traced to the sluggish recovery that came in the wake of the 2007-2008 Financial Crisis.
Household incomes in the United States stagnated during the recovery and anger over rising inequality led to the election of Donald Trump who promised to “Make America Great Again.” [Trump Quote] “I alone can fix it”. He kicked off his presidency by renegotiating Nafta with Canada and Mexico and launching tariff wars with China and other trade partners. When Biden took power in 2021 he continued Trumps policies and added to them. Due to the war in Ukraine and the supply chain issues that had happened during the pandemic, Biden added a strategic argument to justifying this new interventionist approach to trade. There is no way around it though, the need to compete with China, which has for decades provided massive industrial subsidies to its companies, is the main driver of the shift that has occurred in Washington over the last decade or so, and this can be seen in the actions of both Republicans and Democrats.
Biden’s industrial policy has a number of big goals: It seeks to rejuvenate depressed regions, strengthen supply chains, decarbonize the US economy, drive down energy costs and build a fairer more equitable economic order. Critics of these policies worry that the large-scale government spending, is reckless and will push up taxes and worsen inflation in an already overheated economy. They argue that protectionism weakens businesses, who in such an environment organize themselves to collect government subsidies rather than to compete by innovating. While some Republicans have called for a reversal of Biden’s subsidies, they might not actually be willing to pull the subsidies next year if they win the election.
They might not want to look like they are shutting down factories and sending jobs abroad. China’s surpassed Japan as the world’s largest auto exporter in the first quarter of 2023 catching many— including the biggest auto manufacturers — by surprise. Chinese manufacturers found success exporting cheap electric cars to emerging markets, edging out the much more expensive Western alternatives. Historically, we have seen governments unwilling to allow their national manufacturers to lose auto market share like this.
Japan’s success in the 70’s and 80’s led to trade disputes which were only defused when Japanese car companies opened factories in the US and Europe. Today Chinese auto manufacturers face trade barriers like Trumps 27.5 percent import tariff on all Chinese vehicles and Joe Biden’s Inflation Reduction Act subsidies for EVs that meet local content requirements.
In the face of these tariffs and subsidies, Chinese companies struggle to sell cars in the US. The EU’s car market so far remains not just open to Chinese imports, but its EV subsidies have attracted a surge of Chinese car imports — partially because Chinese cars are cheaper and partly because Chinese manufacturers were ahead of European manufacturers in scaling up EV production in recent years. European nations are now beginning to question the current approach of subsidizing these cars, but at present German automakers oppose any protectionism as they don’t want retaliatory tariffs to lock them out of the huge Chinese market for their vehicles.
France, on the other hand, recently announced environmental rules that will have the effect of ensuring that their EV subsidies only apply to cars built in Europe. Even if Chinese EV’s are not sold in any real volumes in the United States, China still produces three-quarters of all lithium-ion batteries and has 70 percent of “production capacity” for cathodes and 85 percent for anodes - all vital components of EV batteries. Rare earth materials which are used in EV motors and all sorts of cleantech applications are mostly produced in China too. China announced export restrictions on some of these products this week and has historically restricted their export in the past citing environmental concerns during a row over disputed islands with Japan. Asian companies have been leading the pack in investing in the United States since the new subsidies were announced. South Korean companies like Hyundai, LG and Samsung have pledged tens of billions of dollars to build battery plants.
Hyundai is also now building an EV factory in Georgia. Japanese firms Panasonic, Toyota, Honda, and Bridgestone have also announced additional spending plans in the United States too. According to UBS, by 2026 Korean battery makers will stand to collect an annual subsidy from the US taxpayer of upwards of $8bn from the Inflation Reduction Act’s “advanced manufacturing production credit” alone. There is a long history of countries using industrial policies to promote specific firms or industries as national champions—good examples would be semiconductors in Taiwan and aerospace in France.
This approach aims to create globally competitive companies, ensuring economic growth and security. While this has been successful in some cases, it remains controversial as government bureaucrats picking winners and losers often leads to market distortions and inefficient allocation of resources. Just because a government supports a sector doesn’t mean economic success will be achieved. Especially when your government has chosen to support the exact same sectors that every other country is also supporting. U.S. solar manufacturing has had years of federal and state subsidies along with tariff
protection and has failed to become globally competitive. The US auto industry fell into decline during the years it was receiving the greatest protection from Japanese competition. The new US industrial policy is being done on a much larger scale today than ever in the past, and it’s causing other countries around the world to respond in kind. Federal loans to Solyndra, the solar manufacturer that went bankrupt in 2011, were $535 million dollars.
This is dwarfed by the Chips and Science program which is putting about $53 billion toward semiconductor manufacturing and development. The Inflation Reduction Act has no cap on spending and might eventually offer $1 trillion dollars in aid to renewable energy. The Energy Department in addition has $400 billion in lending authority at its disposal. Despite the massive scale of these programs, some politicians are eager to do more. In April, US representative Ro Khanna, a congressman representing Silicon Valley, said, “Let’s have a CHIPS act for aluminum, for steel, for paper, for microelectronics, for advanced auto parts and for climate technologies.” Which might lead you to ask at what point does he think government should stop supporting industries.
One worry is that the success of authoritarian regimes around the world over the last few decades has meant that people have less faith in free markets and the judgement of businesspeople spending their own money. This is happening despite the fact that the quality of life in free market economies is significantly higher than in authoritarian countries. Politicians in western countries have frequently expressed their envy over how much easier it is to get things done in countries like China. [Justin Trudeau clip] “The admiration I actually have for China – emmm because their eh basic dictatorship is allowing them eh to actually turn their economy around on a dime” It is not just in the broader economy where politicians have been looking for more control. In Australia Treasurer Jim Chalmers talked of the pension system in terms of the long-term needs of the economy and the financing of “affordable housing, climate, the care economy and digital.”
Saying “We see trillions of dollars in workers’ capital, we see government budgets heaving with debt, and there are obvious needs for investment, particularly in areas like housing and energy.” Similarly in the UK The Capital Markets Industry Taskforce noted that UK pension funds have too much money invested abroad – they aren’t doing what it wants them to do by investing in Britain and they suggested that savers should be persuaded back in with a variety of “structural incentives.” I guess the question we have to ask ourselves is whether it’s reasonable to believe that people in government have the necessary skills and wisdom to pick the right sectors to focus on? When you centralize decision making you lose individual initiative. Would government decision makers do a better job than individuals in deciding how to allocate money and how to pick sectors to focus on. Thirty years ago there was a similar fear that the Japanese model of constant economic intervention was more successful than the free markets approach.
I’ll leave you with a clip of Milton Friedman answering the question of what should the US do to defend its steel industry from Japanese competition. you mentioned about the imports of steel they'd like to allude to that we hear from the American steel industry that in Japan for instance and steel producers are producing it less than cost with support of the government so as to keep employment up there and as a result the American steel industry here is not going to be able to compete so they're going to shut down and we're going to have higher unemployment here what is your answer to that well that's a very very good question and it's a very easy answer because I'm not I may say the answer I'm giving is not my answer it was the answer that was given by Adam Smith the man whose face appears on my tie I may say it was given by Adam Smith in 1776 in the wealth of nations from that time to this hardly any professional economist has believed in in tariffs or protection or anything but free trade but the answer is very straightforward let us suppose for a moment that the Japanese flood us with steel that will reduce employment in the American steel industry no doubt however it will increase employment elsewhere in America we will pay for that steel with dollars what will the Japanese do with the dollars they get for the steel they aren't going to burn them they aren't going to tear them up if they would that would be best of all because there's nothing we can produce more cheaply than green pieces of paper and if they were willing to send us steel and just take back green pieces of paper I can't imagine a better deal but they're not going to do that they're not stupid they're smart people they're going to use those dollars to buy goods and services they're going to spend it in the process of spending them they may spend them directly in the United States then that directly provides employment in the United States they may spend them in Brazil or in Germany or in China or anywhere else but whoever gets him in turn is going to spend them so the dollars that we spend for the steel will find their way back to the US as demand for us goods and services you will have less unemployment in the steel industry you will have more employment in the industries producing the goods we export overall total employment will not be affected but overall the American consumer would be benefited because he will get the steel more cheaply and the goods made from the steel more cheaply than he otherwise won that's the benefit to the American consumer now why is the steel industry in similar industries why are they so effective in their campaigns for protection because of a very common problem that affects not only this but lots of a lot cells and that is the difference between the visible and the invisible the people who are going to lose their jobs and steal are very visible they're a collective group you can name their names suppose we restrict him imports from Japan then people are going to lose their jobs in these export industries they will be widely spread over the country you and I couldn't name one person but that doesn't mean they're any less real but the greater propaganda effect of the steel industry is because you can set the visible is a more potent political force than the invisible people who will lose their jobs I urge on those people who think there's some sense to the steel industry argument to consider it in a more absurd setting you very often bring out the logic of an argument by carrying it to an extreme you know you could have a great employment in in the city of Logan Utah of people growing bananas and hot houses if we had a high enough tariff on the import of bananas it could become profitable to build hot houses and grow a grow of bananas in those hot houses that would give employment would that be a sensible thing to do if that isn't sensible then neither is it sensible to artificially restrict the import of steel now with respect to the charge that the Japanese government is subsidizing the export of steel number one is very dubious that it's true but suppose it were true then that would be a foolish thing for the Japanese to do from their own point of view but why should we object to they're giving us foreign aid we've given them quite a bit thank you you Thanks for watching this week’s video. If you enjoyed it you should watch my video on the rise and fall of Japan next. Don’t forget to check out our sponsor Incogni using the link in the description below.
Have a great week and see you in the next video. Bye.