Time for a real industrial policy

Free trade and unfettered market fundamentalism have failed to deliver broad-based prosperity

Published January 6, 2019 9:29AM (EST)

 (Ryan Dorgan/Casper Star-Tribune via AP, File)
(Ryan Dorgan/Casper Star-Tribune via AP, File)

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

We are living in a time of prescriptions for America’s economic woes that carry little meaning. Forget what you hear on TV: Unfettered free trade, tariffs, de facto “open borders” immigration (a consequence of a political dysfunction that precludes genuine immigration reform), and market fundamentalism have done little to eliminate the paucity of quality employment opportunities. A good New Year’s resolution therefore would be constructing new policies that solve this problem in a viable, long-lasting way, even if it means discarding increasingly outdated shibboleths.

Much of the story of the U.S. and other Western democracies over the past 40 years has been the loss of highly skilled, well-paying jobs, displaced in many instances by the proliferation of low-wage and low-productivity jobs in health care, food service, or becoming a “gig” driver for Uber. The effects have been confirmed in a recent study by McKinsey, which showed that income growth has stagnated or fallen for the majority of households in the advanced economies over the past few decades. The only way to fix this is with direct government spending into the economy. That involvement must be via spending on badly needed public goods, such as infrastructure and publicly funded education.

But that is not the only legitimate role for the state. We also need a well-designed industrial policy that focuses on the creation of quality private sector jobs capable of profitably supporting workers with solid middle-class incomes. These must be accompanied by social policies on immigration, environmentalism and trade that do not simply treat worker displacement as an unfortunate by-product (“negative externality” in econ-speak), cast on the scrap heap of “progress.” Similarly, workers should not be viewed as “deplorables” if and when they understandably object to disproportionately bearing the restructuring costs as the economy moves toward greater environmental sustainability.

Free market fundamentalism has done a great job of extracting value from the economy and largely distributing its gains to the top 1 percent. When governments occasionally find a way to redistribute the benefits of that value extraction to the broader population, whether via a minimum wage, tighter regulation, state intervention, or similar policy, these measures are invariably castigated as wrongheaded, inevitably leading to less efficiency, sub-optimal growth and lower standards of living.

But from whose perspective?

Here’s the thing: Reiterating superficial “reforms” of outdated notions of free trade, liberalized immigration, and “comparative advantage” while ignoring the social pathologies created by these long-standing policies hardly constitutes a realistic policy response. It evokes the definition of madness long attributed to Einstein. Furthermore, in a hyper-globalized world, it is harder to make the case that any nation possesses greater “comparative advantage” other than those obtained through lower labor costs and mercantilist manipulation. Indeed, neither “capacity” nor “comparative advantage” is fixed; both are chosen. They are decisions, not fate. Even natural resources — while still a factor—provide much less relative advantage than in earlier times. Basically, any nation can produce anything. The only issue is relative cost.

Since the developed countries cannot thrive as the lower-cost producers via labor advantage, the only tool left in the pursuit of economic health is to combat mercantilism with mercantilism (or reverse-mercantilism, if you prefer). The policy tools may involve forms of protectionism, but the same results might also be achieved via taxation. Since unemployment is the source of the extended pay benefits provided by the government, the government can, for example, permanently tax the source of the unemployment—U.S. corporations that have historically resorted to offshoring. Taxation done in this manner will help restore a permanent incentive to invest in plants and equipment in the U.S.

Ultimately, the aim is to change the labor share of the production equation, so that production vastly increases general welfare and living standards for the largest possible majority of people. By conducting policy with a view toward favoring labor over capital, the aim is to produce a larger economy, and more stable (albeit restrained) profits. Investors in the stock market might not benefit as much, but the rest of us will.

There is, however, a chicken-and-egg element to the concept of warranted industrial policy. We cannot overstress profits or overprice goods until we have channeled sufficient incomes to households for them to afford higher-priced goods. Otherwise, we have an even bigger personal debt problem than we do now (average American household debt stands at around $130,000). It was a key insight of the noted British economist of the late-19th/early-20th century, John Atkinson Hobson, whose theory of “under-consumption,” as I have written before, “challenged the prevailing ideology of the day, which considered wage suppression to be good for business and society.” In fact, as Hobson pointed out, labor is not just a cost input, but an important source of demand, so restricting the former’s purchasing power can lead to sub-optimal economic growth.

A better policy response (which runs contrary to today’s prevailing neoliberal theology) is to gradually enhance purchasing power by gradually removing direct burdens on households that limit their truly disposable income: State assumption of medical and education costs, and a reform of the tax system, so that it no longer gears fiscal policy benefits largely toward the top 1 percent (who have the highest savings propensities).

Another aspect to this may entail some form of managed trade as well, via local content requirements (LCRs). Here’s how this would work: Every large nation or bloc (it doesn’t work for small countries) would be allowed to adopt local content requirements for the industries it wants, ranging from zero to 100 percent (100 representing the highest military or economic importance). The rest of the world can compete for the remaining share of the national/bloc market.

Free trade theologians will no doubt rebel, but the virtue of this idea is that it reduces the incentive for mercantilism precisely because LCRs make it impossible to drive your trading partner out of a desired industry by dumping. Likewise, currency manipulation doesn’t work to wipe out your trading partner because a large percentage of, say, semiconductor chips must be made in the U.S. under this program, whether the dollar is high or low.

Import substitution via local content requirements is often derided by free market theologians. It is true that import substitution, partial or total, can have its own pathologies, but it has one significant virtue: there is no incentive for dumping-motivated overproduction. No rational private firm is going to make products far in excess of demand in the local market (national or bloc), and there would be no point in governments’ subsidizing products to dump them abroad, because dumping would be deterred by foreign in-market production rules of various kinds (quotas, tariffs, local content requirements).

Granted, this wouldn’t entirely deter dumping, which could still pay off for mercantilist regimes that want to corner the “free” shares of nations/bloc markets. But it would greatly lower the stakes. No major nation or bloc need worry that it will lose any industry it wants to keep to predatory trade practices.

The idea of eliminating everybody’s tariffs instead of granting market access on a case-by-case basis seems to have come from the Wilsonian wing of the Democratic Party led by Cordell Hull, the Tennessee senator, who subsequently became FDR’s Secretary of State for 11 years. Hull and other Southerners had always been for free trade because they had no industries in need of infant industry protection and wanted to sell cotton, soybeans, beef, and any other farm products to the markets of the European empires.

U.S. manufacturing was part of the free trade coalition during the brief moment of U.S. global manufacturing monopoly from the 1940s to the ’70s, but the postwar recovery of East Asia and Germany caused a crisis that U.S. firms solved by offshoring to cheap labor locales rather than pressing to alter trade regimes (or investing to move higher up the technology curve to offset the impact of rising labor costs).

Part of our policy challenge today springs from the fact that we are an advanced industrial economy operating with rules set by long-dead agrarians and justified by an agrarian economic philosophy (Adam Smith, like the French physiocrats, favored farming over premodern sweatshop manufacturing, which they all thought was dehumanizing; they didn’t grasp machine-based manufacturing, which came later).

Accordingly, the 2020s need to be devoted to the end of the 40-year Reagan-Thatcher experiment with unmanaged capitalism based on these archaic rules. Simply letting markets be markets (the dictum of the anti-trust brigade) does not necessarily provide optimal outcomes. In fact, it represents a kind of neoliberalism on steroids. The state needs to be involved so as to rectify the imbalances created by head-to-head competition with highly managed, state-supported forms of capitalism.

A necessary corollary is that export processing zones (EPZs) should be outlawed. Many of them in China or elsewhere require by local law a majority of goods produced to be sold outside of the country in which they are made — protecting local national champions while encouraging dumping and mercantilism.

The key to understanding contemporary global production is our bizarre new quasi-medieval system of territorial enclave arbitrage — EPZs (physical production) and tax havens (finance and IP). Add to that phenomenon the fact that there are elites willing to pay an illegal-immigrant servant class off the books, and you have a system of indentured servitude created by corporations and the rich that evades labor unions, taxes, and labor laws. This new parallel world order of enclaves is incompatible with a global Westphalian system of industrial nation-states based, at least in theory, on popular sovereignty. More and more of the national working-class population gets priced out of the high urban living costs of our major cities and into post-industrial heartlands with no high-value-added industry and no way to use the ballot box in democratic government to tax the rich to pay even for basic services and social insurance. Thus the yellow vests in France, and similar phenomena elsewhere.

Here’s another aspect that would undoubtedly help labor, but no doubt be greeted with profound misgivings by much of the liberal “punditocracy”: immigration reform. We also need an immigration reform bill, not based on building a useless 2,000-mile wall, but one predicated on the Barbara Jordan Commission’s guiding principles(listed below):

1. Clear goals and priorities must define U.S. immigration policy;

2. Effective policy means enforcement of immigration limits;

3. Regular review is needed to ensure flexibility to adjust to changing circumstances in the United States;

4. Immigration policy should be comprehensible and its implementation efficient;

5. Sponsors are responsible for ensuring that immigrants do not become burdens on the American taxpayer;

6. Immigration policy must protect U.S. workers against unfair competition from foreign workers, with an appropriately higher level of protection for the most vulnerable in our society;

7. Both temporary and permanent admissions categories must be seen as integral parts of a cohesive immigration policy;

8. A sound immigration policy supports Americanization, meaning that immigrants share with Americans such values as the belief in liberty, democracy, and equal opportunity;

9. Fundamental immigration reform requires a period of transition to get from the present system to the new one.

For those who chafe against the enforcement of immigration limits, it’s worth noting that, in the words of Professor Bill Mitchell: “corporations love ‘free movement’ (of both capital and people) because in the latter case they can use the excess supply of labour to batter the existing workers and their organisations into accepting worse pay and conditions.” But to ensure that the immigration laws are both humane and equitable, rather than placing the burden of enforcement on the immigrants themselves, immigration limits are best achieved by mandating “e-verify” for all employers — and capping the number of contractors an employer can hire as a percentage of full-time workers. Immigration should also prioritize entrants on the basis of skill, not family or race. Once we have a proper functioning immigration system, labor markets will likely tighten, and the minimum wage can be raised without expanding the black market in labor. This would also help to redress somewhat the significant power imbalance between capital and labor, as the former relies on an “army of unemployed” to mitigate wage increases.

The traditional rebuttal from the likes of the Organization for Economic Cooperation and Development (OECD) (or the Harvard economics department) is that rising wages, dwindling capacity, and continuing “trade frictions” all spell inflation, loss of competitiveness and, with it, less profitability and economic prosperity. The loss of competitiveness is addressed via the local content requirement rules. The other thing that never seems to occur to our experts is that productive and absorptive capacity themselves both grow as wealth and income rise beyond the top income recipients.

Ultimately, the end goal is to produce a larger proportion of our own consumption, at least for the remaining quarter to half century, before the new entrants to the global economy consume a larger proportion of their own production. Policy can work from two ends: one, provide lift from the bottom by assuming more social expense currently borne by households and firms (in health care, for example), and two, provide “suction” from above by sucking up the underemployed into better-paying public infrastructure jobs. One thing is clear: The status quo is not working, and some radical rethink is going to be required when the next economic crisis befalls us.

By Marshall Auerback

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