– November 18, 2019
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Industrial policy is back in fashion.

It’s unsurprising that many people on the political left believe that the economy can be improved by putting large chunks of it under the direction of politicians and their bureaucratic minions. The political left deeply believes that the allocation of resources that results when individuals invest their own money as entrepreneurs, and spend their own money as consumers, is inferior to the allocation that would be achieved if the state directs investment and, thereby, necessarily also overrides many of the consumption decisions that would be made in free markets.

Yet it’s jarring – and disappointing – to encounter a case for industrial policy in the opinion pages of the Wall Street Journal. But there it is, offered up proudly by Sridhar Kota and Tom Mahoney. Their labeling it “Industrial Policy 2.0” is a futile attempt to distinguish it from any of the sorry entries on the long list of past industrial-policy failures.

The very title of the piece – “Innovation Should Be Made in the U.S.A.” – puts the economically informed reader on notice that the text of the piece is likely to be economically uninformed. The warning is warranted. And while the authors likely didn’t choose the title, it accurately reflects the authors’ mistaken suggestion both that the U.S. is lagging in innovativeness, and that innovation that originates within the U.S. is necessarily better for Americans than is innovation that originates elsewhere.

Fallacies Galore

Consider this startling claim: “Once manufacturing departs from a country’s shores, engineering and production know-how leave as well, and innovation ultimately follows. It’s become increasingly clear that ‘manufacture there’ now also means ‘innovate there.’”

First, manufacturing is not departing from America’s shores. Real manufacturing output in the U.S. is today near an all-time high. And this output would almost certainly be even higher were it not for the Trump administration’s economic-nationalist policies. Ironically, such policies are the very sort that Kota and Mahoney – who explicitly criticize what they contemptuously call “the outsourcing paradigm” – endorse as a means of boosting manufacturing in the U.S.

Second, despite their insinuation that engineering and production know-how are leaving the U.S., or are threatening to leave, the authors present absolutely no evidence to back this insinuation – an insinuation that is almost impossible to square with the reality that U.S. manufacturing (it cannot these days be said too often) is today near an all-time high.

Third and more fundamentally, when and to the extent that trade and markets are free, Americans benefit from innovation no matter where it occurs. Kota and Mahoney seem blind to the reality that if Lee in Shanghai figures out how to produce steel at a lower cost, Americans who are free to buy steel unimpeded on global markets reap the benefits of the resulting lower price of steel no less than if this innovation were done by Lou in Youngstown.

Fourth and even more fundamentally, the authors mistakenly write as if the amount of innovation is fixed.

Yes: if a foreign country attracts more investment to create manufacturing plants it will likely also become the site of greater innovation. This fact is so in part because an increased number of factories that produce outputs for sale in competitive markets naturally inspires people who work in those factories to creatively devise better and more efficient uses of those factories. But greater innovation in these cases also comes from a deeper source – namely, the improved policy climate that itself heightened the attractiveness of putting factories in those locations.

Countries that attract more investment typically are countries whose public policies and private attitudes have become more favorable to markets, including to the innovation which is the source of economic growth. So it’s quite natural that as countries industrialize according to market forces the peoples of those countries unleash more of their innovative energies.

Importantly, this increased innovation abroad does not decrease innovation here in the U.S. Innovation here is merely rechanneled into different avenues.

Stop Dissing the Service Sector

One of these avenues is the service sector. This sector (although you’d never guess it by reading Kota and Mahoney) has for a century now been the single largest sector of the American economy. As the U.S. manufacturing sector continues to shrink relative to the U.S. service sector, a greater portion of American innovation occurs in the provision of services. Yet Kota and Mahoney mistakenly write as though innovation is driven exclusively by manufacturing and occurs exclusively in that sector.

By the way, don’t suppose that innovation in manufacturing is somehow better than innovation in services. Among the most spectacular innovations since the end of World War II are Sam Walton’s, and later Jeff Bezos’s, revolutionary improvements in retailing. Other innovations in services are Fred Smith’s creation of affordable overnight package delivery and Sergei Brin and Larry Page’s improvements in search engines. And let’s not forget innovative services such as ride-sharing, music streaming, and social media.

I can’t resist here giving a shout-out to one of my favorite entrepreneurial service providers: Jiffy Lube. Oil-changing services are, perhaps, not very high-tech, but they save me and millions of other Americans enormous amounts of time. Surely some of this saved time is spent being innovative.

Had the portion of resources and creative human energies Americans devote to manufacturing not fallen over the past several decades, fewer – and perhaps none of the above-listed – innovations in services would have occurred. As a result, we Americans (and non-Americans) would have been poorer.

A Fallacy Wrapped In a Contradiction

A smorgasbord of other fallacies, factual and logical, runs throughout Kota and Mahoney’s case for industrial policy. I close, however, by flagging this one sentence: “We have lost much of our capacity to physically build what results from our world-leading investments in research and development.”

It’s an erroneous factual claim wrapped in a contradiction. 

The erroneous factual claim is the one about production capacity. In fact, U.S. industrial capacity is today at an all-time high. And so we have not “lost much of our capacity to physically build.” Also, if this assertion by Kota and Mahoney were correct, explaining why American manufacturing output is now near an all-time high would be challenging, to say the least.

The contradiction arises when the authors mention “our world-leading investments in research and development.” Because our imports of manufactured goods have steadily increased for decades, how can it be that today we have “world-leading investments in research and development” given the authors’ thesis that innovation dries up as we Americans import ever-more of the manufactured goods that we use?

Conclusion

Any case for industrial policy reflects the economic and factual understanding of those who offer it. With their Wall Street Journal essay, Kota and Mahoney join a long roster of economically and factually uninformed individuals who’ve tried to make a cogent case for industrial policy – individuals who, in every case, have failed.

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Donald J. Boudreaux

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Donald J. Boudreaux is a senior fellow with American Institute for Economic Research and with the F.A. Hayek Program for Advanced Study in Philosophy, Politics, and Economics at the Mercatus Center at George Mason University; a Mercatus Center Board Member; and a professor of economics and former economics-department chair at George Mason University. He is the author of the books The Essential Hayek, Globalization, Hypocrites and Half-Wits, and his articles appear in such publications as the Wall Street Journal, New York Times, US News & World Report as well as numerous scholarly journals. He writes a blog called Cafe Hayek and a regular column on economics for the Pittsburgh Tribune-Review. Boudreaux earned a PhD in economics from Auburn University and a law degree from the University of Virginia.
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