America’s industrial policy

In the wake of proposals by President Obama and the two leading Republican Presidential candidates, Mitt Romney and Rick Santorum, for tax breaks and other measures to support manufacturing, there has been an outcry from economists against industrial policy. Former Council of Economic Advisers Chairwoman Christine Romer, for example, wrote in the New York Times that there are no good reasons to give special assistance to manufacturing.

But Harvard Business School professor Gary Pisano now makes an excellent point in the latest Harvard Business Review that America has actually long had an industrial policy, and it’s a policy that is essentially anti-manufacturing.

Pisano notes that U.S. agriculture is and has long been heavily subsidized. The bill is about $50 billion annually and among other things provides about $160,000 every year to each U.S. cotton farm despite the fact that American cotton farmers are much higher cost producers than those in Africa and the Middle East. Universities are tax exempt and receive large government research grants. Health care also receives an enormous tax break because employer provided health care plans are paid for with pre-tax dollars. The home mortgage interest tax deduction provides a huge subsidy to the housing industry and also stimulates loans for the banking industry. Finally, Pisano notes that the private equity industry is heavily subsidized with an income tax rate called carried interest that is set at 15 percent. This is what enabled Mitt Romney to pay taxes at a rate about half that of the rest of you gentle readers. Just imagine what U.S. manufacturing would look like if it paid a 15 percent income tax rate.

Pisano could have added to his list the U.S. military-industrial complex. Without the military business there would be no U.S. shipyards. Lockheed and a host of other major corporations would be shadows of their present selves or not exist at all without the Pentagon business. Then there is medical research. The National Institute of Health (NIH) spends more on bio-tech research than the rest of the world combined. That, of course, explains why the U.S. bio-tech industry is the world leader. Then there are the subsidies for big oil and the support given the airline industry through public funding of airports and of the Federal Aviation Administration that operates the radar and flight control systems across the country. Contrast that to the railroads that have to maintain their own systems and rights of way.

Finally, there is the big enchilada, the financial industry. Consider that its profits in 1980 were 6 percent of all business profits. By 1990 that number was 30 percent and by 2005 it had soared to 40 percent. How did that come to be? Abolition of regulatory rules like the Glass-Steagll Act, "light touch" regulation of banks by the Federal Reserve, the carried interest tax rates noted above, and loosening of the rules to allow banks to expand their loan to net capital ratios are just some of the special supports provided to the financial industry. Then, of course, when it all came crashing down in 2008-09, Washington bailed Wall Street out and didn’t even fire anyone. So the guys who gave us the crisis are still riding high .

It looks to me as if the only part of the economy not getting special help, indeed, being neglected and even attacked by the government is manufacturing. 

Of course, our tax system also subsidizes consumption and taxes saving and investment. So the American industrial policy is to over-consume, promote agriculture, military production, housing and construction, medical care, finance, and provision of a variety of services while moving manufacturing and all but medical R&D off-shore.

I don’t understand why economists can’t see that the issue is not whether we have an industrial policy. It’s only what kind of industrial policy we’re going to have. The fantasy of pristine free markets is just that – a fantasy that exists only in the economists’ models. In the real world, there is inevitably massive government intervention in the economy. It is not going to go away. At the moment, American industrial policy is a residual, what de facto emerges from the arbitrage of special interests. It is incoherent, self-contradictory, and counter-productive for U.S. economic performance.

Rather than opposing industrial policy economists should be promoting one that could provide a rational framework within which the trade-offs could be made in a way that would be positive for long term wealth creation. Manufacturing would then not be a despised orphan, but would be treated at least as kindly as banking and finance.