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America Will Keep Losing Its Middle Class as Long as 'Free Markets' Dominate the Economic Debate

We need to invest in research and development if we’re going to strengthen the middle class and compete in a global market.

The U.S. began to adhere to a doctrine of shareholder capitalism in the 1980s and beyond, a philosophy that minimized the role of the state, and gave primacy to short-term profitability, as well as production growth through efficiency (i.e., downsizing) and mergers. (Photo: iStock)

The U.S. began to adhere to a doctrine of shareholder capitalism in the 1980s and beyond, a philosophy that minimized the role of the state, and gave primacy to short-term profitability, as well as production growth through efficiency (i.e., downsizing) and mergers. (Photo: iStock)

National industrial policy was once something you might read about in today’s equivalent of a friend’s Facebook post, as hard as that might sound to believe. It was in newspapers; it was on the radio. Taxi drivers had opinions about it. That all changed in the last 35 years, when the rise and fall of the stock market and a shallow conversation about unemployment rates took over. Industrial policy became an inside-baseball conversation, and to the extent that it was discussed, it was through the prism of whether it imperiled the golden gospel and great economic distraction of our time, “the free market.”

The decades of free-market propaganda we’ve been exposed to are basically an exercise in distracting the public from the meaningful choices that are now made behind closed doors. The two big political parties that outwardly represent symbolic issues like gun rights and school prayer spend the bulk of their time and political energy on complex industrial and regulatory questions.

But much like Nero fiddling while Rome burned, they’d better start considering the question of a national industrial policy before there’s no industry left to manage. Manufacturing is now at its smallest share of the U.S. economy in 72 years, reports Bloomberg. Multinational supply chains undermine the negotiating power of workers, thereby exacerbating inequality.

Are there ways to bring back manufacturing, or should we just capitulate to a mindset that argues that these jobs are gone for good, that software retention is good enough, even as we shift what’s left of our manufacturing sector overseas to sweatshop economies? That seems short-sighted. After all, it’s pretty easy to steal IP; it’s not so easy to steal an auto manufacturing facility. The real question is: In the absence of some sort of national industrial strategy, how do Western societies retain a viable middle class?

Decades of American middle-class exposure to favor China and other Asian countries’ industrial capacity have foisted it right back from elite circles into our politics and the ballot box, in spectacular fashion, through the unlikely Donald Trump, who, in his typically blunderbuss fashion, has called attention to some serious deficiencies in our current globalized system, and the competitive threat posed by China to which we have remained oblivious for all too long.

Not that Trump’s 19th-century protectionism represents the right policy response, but his concerns about Beijing make sense when you compare how much China invests in its own industrial base relative to the U.S.: Robert D. Atkinson and Caleb Foote of the Information Technology and Innovation Foundation write that a recent Harvard Business School “study estimated that the Chinese governments (national, provincial, and local) paid for a whopping 22.2 percent of business R&D in 2015, with 95 percent of Chinese firms in 6 industries receiving government cash—petrochemicals, electronics, metals and materials, machinery and equipment, pharmaceuticals and biotechnology, and information technology.”

In addition to the direct government grants on R&D, Atkinson and Foote estimate that “the Chinese R&D tax credit is between 3 and 4.6 times more generous than the U.S. credit. To match China’s R&D tax credit generosity, the U.S. rate for the Alternative Simplified Credit would have to be increased from 14 percent to between 35 and 40 percent.” Atkinson and Foote also note that “97 percent of American federal government funding went to just three sectors: transportation equipment, which includes such as fighter jets, missiles, and the like ($14 billion); professional, scientific, and technical services ($5 billion); and computer and electronic products ($4 billion).”

Taken in aggregate, Atkinson and Foote calculate that “nearly 25 percent of all R&D expenditures in China come in the form of government subsidies to firms.” That’s the sort of thing that must enter the calculations of antitrust advocates when they call for breaking up big tech, without considering the ramifications to research and development, especially relative to their Chinese counterparts. (Statistically, as Anne Marie Knott and Carl Vieregger find in a 2016 paper “Reconciling the Firm Size and Innovation Puzzle,” there are ample studies illustrating that R&D spending and R&D productivity increase with scale.)

Why does this matter? Robert Kuttner, writing at the Huffington Post at the inception of Barack Obama’s presidency, made a compelling argument that many of America’s great industrial enterprises did not simply spring up spontaneously via the magic of the "free market:"

American commercial leadership in aerospace is no naturally occurring phenomenon. It reflects trillions of dollars of subsidy from the Pentagon and from NASA. Likewise, U.S. dominance in pharmaceuticals is the result of government subsidy of basic research, favorable patent treatment, and the fact that the American consumer of prescription drugs is made to overpay, giving the industry exorbitant profits to plow back into research. Throwing $700 billion at America’s wounded banks is also an industrial policy.

So if we can have implicit industrial policies for these industries, why not explicit policies to rebuild our auto industry, our steel industry, our machine tool industry, and the industries of the next century, such as green energy and high-speed rail? And why not devise some clear standards for which industries deserve help, and why, and what they owe America in return?

In fact, Kuttner describes a problem that well preceded Barack Obama. America’s belief in national industrial planning has been undermined to the extent that the U.S. began to adhere to a doctrine of shareholder capitalism in the 1980s and beyond, a philosophy that minimized the role of the state, and gave primacy to short-term profitability, as well as production growth through efficiency (i.e., downsizing) and mergers. Corporate prioritization of maximizing shareholders’ value and the ways American corporations have minimized long-term R&D expenditures and capital investment, all of which have resulted in the “unproductive disgorging of corporate cash profits—through massive dividend payouts and unprecedented spending on stock repurchases—over productive investment in innovation,” write Professors Servaas Storm and C.W.M. Naastepad.

Although European companies have not gone quite as far down that route, their “stakeholder capitalism” culture has been somewhat subverted to the same short-term goals as their American counterparts, as evidenced via Volkswagen’s emissions scandal and the erosion of workers’ rights via the Hartz labor “reforms” (which actually undermined the unions’ stakeholder status in the companies, thereby freeing up management to adopt many of the less attractive American shareholder capitalism practices). The European Union too is now belatedly recognizing the competitive threat posed by China. There’s no doubt that the European political classes are also becoming mindful that there are votes to be won here as well, as Trump correctly calculated in 2016.

In the U.S., industrial policy is increasingly finding advocates on both the left (Elizabeth Warren’s policy director, Ganesh Sitaraman) and the right (Professor Michael Lind), via the convenient marriage of national security considerations and with international investment and trade. If trade policy is ultimately subordinated to national security concerns, it is conceivable that industrial policy could be “bi-partisanized,” thereby giving primacy to homegrown strategic industries necessary to sustain viable national defense and security.

But this approach is not without risks: it is unclear whether the “national security-fication” of the industrial policy renaissance will actually enhance or hinder creativity and risk-taking, or merely cause these firms to decline altogether as viable civilian competitors vis a vis Beijing. The current travails of Boeing provide a salutary illustration of the risks of going too far down the Pentagon rat hole. And there are a number of recent studies illustrating that the case for “dual-use” (i.e., civilian and military) manufacturing does not substantially enhance civilian industrialization and, indeed, may retard overall economic growth. On the other hand, as the venture capitalist William Janeway highlights in his seminal work, Doing Capitalism in the Innovation Economy, there are advantages at times to being “[d]ecoupled from any direct concern with economic return… [It allowed] the Defense Department… [to] fund numerous alternative research agendas, underwriting the ‘wasteful’ search for solutions that inevitably accompanies any effort to push back the frontiers of knowledge.” So there’s a balance to be struck here. But, as Janeway notes, “the strategic state interventions that have shaped the market economy over generations have depended on grander themes—national development, national security, social justice, liberation from disease—that transcend the calculus of welfare economics and the logic of market failure.”

Furthermore, to the extent that national security considerations retard offshoring and global labor arbitrage, it can enhance the prospects for a viable form of “national developmentalism,” given that both mean tighter labor markets and higher wages, which in turn will likely push firms toward upgrading R&D spending in order to upgrade on the high end of the technology curve (as Seymour Melman argued years ago), as well as enhancing productivity gains. As author Ted Fertik observes:

“Higher productivity makes possible more generous welfare states, and helps national industries compete to supply the world with high-tech products. If technological leadership and a prosperous, patriotic citizenry are the surest guarantees of military preponderance, such an economic policy represents the best military strategy in an era of great power competition.”

Both the left and the right are beginning to recognize that it makes no sense to make war on wage-earners while claiming to protect the same wage earners from Chinese competition. But governments need to do more than act as a neutral umpire, whose role never extends beyond fixing market failures. As Janeway has illustrated, governments have historically promoted the basic research that fueled innovation and nurtured the talent and skills that “became the foundation of the Innovation Economy”; “the central research laboratories of the great corporations were first supplemented and then supplanted by direct state funding of research.” But in spite of providing the foundational research for a number of leading commercial products (e.g., Apple’s iPhone), the government has proved reticent in considering alternative forms of ownership structure (e.g., a “government golden share,” which gives veto rights on key strategic issues, such as relocation, offshoring, special voting rights, etc.), or retaining intellectual property rights and corresponding royalty streams to reflect the magnitude of their own R&D efforts, as Professor Mariana Mazzucato has proposed in the past. At the very least, we need to consider these alternative ownership structures that focus entrepreneurial development on value creation, as opposed to capitulating to the depredations of rentier capitalism on the spurious grounds that this is a neutral byproduct of the market’s efficient allocation of resources.

Within the U.S., national industrial policy also suits green advocates, such as Senator Bernie Sanders, whose Green New Deal plan, while failing to address domestic/local content, or manufacturing in the broadest possible sense, at least begins to move the needle with regard to the federal government building and owning a national renewable grid.

Likewise in Europe, German Economy Minister Peter Altmaier recently published a “National Industrial Strategy 2030,” which, according to Dalia Marin of Bruegel think tank in Brussels, “aims to protect German firms against state-subsidized Chinese competitors. The strategy identifies key industrial sectors that will receive special government support, calls for establishing production of electric-car batteries in Europe, and advocates mergers to achieve economies of scale.” It is striking that EU policymakers, such as Lars Feld of the German Council of Economic Experts, still apparently think it is a protectionist step too far to consider coordinating with the car companies (where there is already a high degree of trans-European policy coordination and international consolidation), and other sectors, to help them all at the same time—as Beijing is now doing. Of course, it would help to embed this in a manufacturing-based Green New Deal, but it represents a healthy corrective to offshoring advocates who continue to advocate that their car industry should migrate to China, on the short-term grounds of cost consideration alone

Essentially, the goal should be to protect the industries that policymakers think will be strategically important from outsiders, and to further integrate with allies and partners to achieve efficiencies and production scale. (Parenthetically, it seems particularly perverse right at this juncture for the UK to break away from all this continental European integration, and to try to go it alone via Brexit.) The aim should not be to protect private rent-seeking and increasing private monopolization under the guise of industrial policy, which, as Dalia Marin notes, is why EU Competition Commissioner Margrethe Vestager blocked the proposed merger between France’s Alstom and Germany’s Siemens. The two companies “rarely compete with CRRC in third countries, because the Chinese company mainly focuses on its home market.” Hence, the grounds for creating “heavyweight champions” was really a cover for developing an oligopoly instead.

Much of the focus of negotiation in the seemingly endless trade negotiations between the U.S. and China has been on American efforts to dismantle the wave of subsidies and industrial support that Beijing furnishes to its domestic industries. This seems both unrealistic as well as being the exact opposite of what the U.S. should be doing if it hopes to level, or at least carve up, the playing field.

Likewise, the problem in both the EU and the U.S. is not the size of these companies generated by national developmentalism, but a size-neutral form of national regulation that precludes these companies from stifling competition. The goal of a truly successful and workable industrial policy should be to create an environment that supports and sustains value creation and that socializes the benefits of the R&D for society as a whole, rather than simply licensing it or selling it on to private companies so that it just becomes a vehicle that sustains rent extraction for private profits alone.

We are slowly but surely starting to move away from market fundamentalism, but we still have yet to make the full conceptual leap toward a sustainable industrial policy that creates an economy for all. At least this is now becoming a fit discussion as far as policy making goes, as many of the neoliberal shibboleths of the past 40 years are gradually being reconsidered and abandoned. That is a start.

This article was produced by Economy for All, a project of the Independent Media Institute.

Marshall Auerback

Marshall Auerback

Marshall Auerback is Market practitioner/analyst, Research Associate at the Levy Economics Institute of Bard College.

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