Industrial Policy Can't Solve Manufacturing's Difficulties

Investor's Business Daily

Having failed miserably in its effort to shore up U.S. manufacturing with trade protection, it now appears that the Bush administration is preparing to use direct government subsidies instead. Like the ill-fated steel tariffs, this effort, too, is doomed to failure.

As is so often the case, the Bush administration is approaching the alleged problem of manufacturing's decline as if no one had noticed it.

This results from the fact that administration initiatives are never studied or analyzed carefully before being announced. This is one area where former Treasury Secretary Paul O'Neill's criticism of the Bush administration is right on target.

If anyone had bothered to check, they would have found that the federal government has been issuing detailed reports on the demise of manufacturing for over 20 years.

In September 1980, the Carter administration put out a 2-inch-thick report on the decline of American competitiveness. In 1985, the Reagan administration followed up with a two-volume report.

Well Covered

In addition, extensive studies have been done by the U.S. International Trade Commission, the National Research Council, the U.S. General Accounting Office, the Office of Technology Assessment, the Congressional Budget Office and others.

I have a whole shelf of congressional hearings and committee reports, as well.

Then there are all the books. Some of the more notable are "The Deindustrialization of America" by Barry Bluestone and Bennett Harrison (1982), "Manufacturing Matters" by Stephen Cohen and John Zysman (1987) and "In Praise of Hard Industries" by Eamon Fingleton (1999).

Books by Laura Tyson and Robert Reich even got them Cabinet appointments in the Clinton administration.

The point is that the ground was already well plowed before the Bush administration decided to turn its attention to the decline of manufacturing, which it did in a new report from the Commerce Department last week.

Yet at the end of this exercise, the Bush administration could do no better than propose more taxpayer money to help private businesses do their jobs. According to press reports, the 2005 budget will propose substantially increasing spending for the Manufacturing Extension Partnership — a program it proposed phasing out just last year.

Back when people started complaining about the imminent disappearance of manufacturing, the proposed solution — especially popular among Democrats — was an "industrial policy."

The idea was that some government agency, modeled after Japan 's Ministry of International Trade and Industry, would pick industrial winners and losers, nurturing the former with subsidies and trade protection, while humanely killing off the latter.

While popular on Capitol Hill for a time, it died when liberal economists at the Brookings Institution took it apart. Among the leading opponents was Charles Schultze, chairman of the Council of Economic Advisers under President Carter.

Indeed, Schultze injected one of the most effective critiques of industrial policy ever written into the 1981 Economic Report of the President.

Said the Economic Report: "It is presumptuous to assume that successful identification of winning and losing industrial sectors is possible. . . . Even within so-called "losing' sectors, individual firms often outperform many of the firms in "winning' sectors.' "

The effect of adopting an industrial policy would be to further politicize the economy and reduce economic efficiency, the Economic Report concluded. The net effect would be to reduce the competitiveness of the manufacturing sector, not increase it.

The recent history of Japan is ample illustration of the wisdom of this analysis. Its economy has been in the tank for a decade, and many economists blame MITI for the failure of Japanese companies to adapt and adjust to changing market conditions.

The irony is that the new Commerce report presents ample evidence that manufacturing in the U.S. is quite healthy. U.S. manufacturing productivity is rising relative to Germany , France and the United Kingdom after falling for many years. Manufacturing output is strong and retains its historical share of private economic growth.

Two Problems

It is true that employment is down, but manufacturing's share of total employment has fallen by a similar percentage in every industrialized country — including those with active industrial policies.

Echoing a recent report from the National Association of Manufacturers, the Commerce Department study concludes that manufacturing's problems, such as they are, stem mainly from two factors.

First is the general macroeconomic environment. When the economy as a whole grows faster, so does manufacturing. Hence, the economic recovery will powerfully aid manufacturing.

Second are the burdens that have been disproportionately imposed on manufacturing by an out-of-control tort liability system, government regulations and an international tax system that is woefully outdated. These are not problems that trade protection or government subsidies can fix.

The new Bush industrial policy may be nothing more than minor election year politicking. But it's still a bad idea.