Industrial Policy: A Dissent to Charles Schultze’s Dissent

Industrial policy is back on the table in Washington after a 35-year hiatus and a still-born birth in the 1980s. At that time, the United States faced robust international competition, especially in manufacturing from countries like France, Germany, and of course, Japan. In response, many pundits, scholars, and elected officials began to advocate for developing specific policies to help U.S. advanced industries compete globally.

Many are unaware of the significant accomplishments of this advocacy, including the creation of the R&D tax credit, the passage of the Bayh-Dole Act, the establishment of industrial programs at NIST and NSF, the passage of the tougher trade enforcement provisions pressuring Japan to move production to the United States, and many more helpful provisions that in sum helped shore up U.S. industrial and technological competitiveness.

But despite these beneficial individual provisions being put in place, the nation failed to implement a coherent national industrial policy. While individual programs and policies could make it through the Washington policy meat grinder, the concept of a coherent industrial policy could not. If one person and one article could be credited with killing the industrial policy baby, it was Brookings Institution scholar Charles Schultze and his seminal 1983 article, “Industrial Policy: A Dissent.” Coming from Brookings, which couldn’t be easily accused of being a bastion of free-market ideology, and from Schultze, Jimmy Carter’s chair of the Council of Economic Advisors, the article paper was incredibly influential. It was as if Moses had come down from Mt. Sanai, showing us the Lord’s truth and banishing the industrial policy heretics from the neoclassical, free-market economic temple.

The only problem is that Schultze’s argument made little sense then or now, and his admonishment to eschew industrial policy was flat-out wrong. So even though the article is now almost 40 years old, it’s worth a modern-day dissent, in part because he laid out the guide that industrial policy opponents continue to rely on to this day.

Schultze starts by informing the industrial policy know-nothings that the only reason their views (and the then currently popular supply-side economists) were getting a hearing is because the United States suffered from back-to-back recessions in the early 1980s. Nothing to see here, folks, just a nasty business cycle dip and no need for any policy change. In reality, that cyclical downturn was the first real warning of a serious structural decline in U.S. competitiveness.

Schultze then denies the fundamental premise of industrial policy supporters—that the United States was “deindustrializing.” Just as Washington Economic Consensus adherents today make the same claim, it was wrong then and even more wrong now. As the U.S. Bureau of Labor Statistics reported, “Many manufacturing industries…. never recovered from the two recessions” (of the early 1980s). The decline in the last two decades was much worse, with real (inflation-adjusted) U.S. manufacturing value-added as a share of GDP for 18 of 19 U.S. manufacturing industries (leaving out NAICs 334, computers, and electronics where output growth is vastly overstated by the government) the picture has been and looks bleak. Manufacturing value-added as a share of GDP declined from around 12 percent in 2006 to around 10 percent in the second quarter of 2021. If this annual rate of decline continues for the next 30 years, U.S. manufacturing output as a share of GDP will be just 6.9 percent.

Second, Schultze then denies that other countries’ successes had anything to do with their own industrial policies. Japan, he argues, didn’t become an advanced economic power because of industrial policy; it just happened because of its natural comparative advantage. But this is ideology speaking, not analysis, because Schultze never actually studied Japan’s development. But as Joe Studwell argues in his definitive book How Asia Works, countries in Asia that adopted smart industrial policies, including Japan, South Korea, Singapore, Taiwan, and now China, grew dramatically, while those that relied on market forces did not.

Third, as many opponents of industrial policy continue to do today, Schultze distorts the meaning of the concept of industrial policy, arguing that it is about supporting “losers”: protecting declining industries by subsidies and trade protection. Yet, few industrial policy proponents at the time and even fewer do today envisioned industrial policy as propping up the lame and infirmed. Instead, it’s all about helping companies and industries be more productive, innovative, and competitive. To the extent it is focused on struggling industries, it is mostly to limit the harm to them from unfair foreign trade practices, such as massive industrial subsidies.

Schultze then reads from the neoclassical bible, holding that only the market can determine the ideal industrial structure, writing:

The first problem for the government in carrying out an industrial policy is that we know precious little about identifying, before the fact, a ‘winning’ industrial structure. There does not exist a set of economic criteria that determine what gives different countries preeminence in particular lines of business.

As ITIF has noted, we know precious much about determining the ideal industrial structure: Is the industry traded? Is it higher value-added? Is it related to the broad defense industrial base? Anyone with a modicum of objectivity knows that industries like semiconductors, biopharmaceuticals, advanced machinery, AI, and autonomous systems are critical to America’s economic and military future. They are more important than car dealerships and waste-paper producers. Yes, potato chips are less important than computer chips.

Strangely, but perhaps not surprisingly, Schultze rejects policies that seek to expand the share of production in high value-added jobs and sectors, arguing that it would lower employment and output because it would increase the capital-labor ratio. This is a surprising error by someone who was once head of the Council of Economic Advisors. By his logic, the United States and other advanced, capital-intensive economies should have massive unemployment compared to other nations like India and most African countries that employ little capital. In reality, higher value-added production leads to higher wages, which leads to increased demand, which in turn leads to job creation.

He then raises a number of bogus arguments, such as widespread tariff protection would be bad. But this is a red herring since industrial policy supporters argued that this should not be part of an effective industrial policy, except to respond to foreign unfair trade practices.

And he falls back on the old saw—one that Washington Consensus advocates still rely on: stop moaning about industrial loss and just give laid-off factory workers a few bucks. That way, when they lose their job making $40 an hour at an advanced industry firm, the government will help them transition to a $10 an hour service sector job, maybe with wage insurance for a few years.

And like the industrial policy opponents of today, Shultze says it’s impossible for the federal government to have effective policies, claiming that they will be all things to all people. But this overlooks the extremely successful track record of U.S. advanced tech policy over the last 75 years at institutions like DARPA, NIH, NIST, and NSF. For example, NIST’s former Advanced Technology Program, a program that provided funding to industry to work on advancing certain technologies, was rigorously evaluated and found to be highly effective.

Finally, Schultze closes his ideological screed by saying that policymakers should focus on the real problems—managing the business cycle, reducing the budget deficit, fixing the education system, and of course, the neoclassical economists’ holy grail: a tax code that taxes all industries and activities the same.

Schultze had every right to publish this dissent. But to claim that he was only reflecting the science of economics was wrong. He was reflecting the ideology of conventional economics, which was and continues to be a fundamentally flawed discipline for thinking about a nation’s industrial structure.

In Schultze’s day, America was competing with our allies, and if we lost out, the worst that could happen would be fewer good jobs for Americans. Today we are competing with a global adversary, China, and if we lose, which it appears we will (absent policy change), the result will be much worse than fewer good jobs. It will be the permanent decline of America as the global leader. With these stakes, it’s time to stop listening to neoclassical economists when it comes to industrial policy.