This article is a part of the Perspectives on Industrial Policy symposium.
From a broad perspective, could you provide us an overview of the current trends toward implementing industrial policy?
It’s important to note that the United States has always had some level of industrial policy, which we define as targeted government interventions to correct perceived market failures in the manufacturing sector. Essentially, that the market isn’t producing sufficiently, so the government needs to get involved. This involvement isn’t via broad macro policies like tax cuts or monetary policy, but through targeted interventions, subsidies, tariffs, etc.
The United States has been involved in industrial policy for a long time and, contrary to the idea that we’ve long been governed by “free-market fundamentalists,” in reality, libertarians were most definitely not running Washington in the 1980s, ‘90s, and 2000s. If you look at recent history, in fact, there’s a long list of industrial-policy interventions: the Jones Act, steel tariffs, anti-dumping measures, ethanol subsidies and mandates, among others. These were all quite popular among American politicians, whether it was in the 2009 stimulus package or back in the ‘80s and early ‘90s, when Japan was seen as the big economic threat.
The rest of the world has engaged in this too. China, being the big actor here, made a pretty radical turn from its liberalization of the 1980s and 1990s. The Chinese government turned toward industrial policy around the late 2000s and early 2010s, right after the Great Recession.
The big difference today is that we’ve seen a massive increase from that baseline, with many countries adopting a China-style approach. The most notable is the United States under the Biden administration, where three pieces of legislation have been implemented: the CHIPS Act, the Inflation Reduction Act, and the Bipartisan Infrastructure Law. These programs showered trillions of taxpayer dollars onto favored industries: semiconductors, renewables, steel and aluminum producers, and others. When combined with the first Trump administration’s increase in tariffs on metals, washing machines, solar panels, and a few other things, the United States has radically increased its industrial-policy involvement since about 2018.
A bunch of other countries have followed the U.S. lead. According to Global Trade Alert, which tracks this type of activity, there were 2,500 new industrial-policy measures in 2023 alone, totaling trillions more dollars in mainly developed country subsidies. Rich countries are subsidizing many of the same sectors, particularly semiconductors and renewables.
The United States, being a big driver behind this trend, needs to take some of the blame. While Chinese state capitalism has long involved government intervention, and the United States was responding in part to Chinese industrial policy, the reality is that U.S. interventions really broke the dam for the rest of the world. After the Trump-era tariffs and especially the Biden-era subsidies, other countries said, “if the United States is going to do it, we either can do it or have to do it as a response.” This led to a global subsidy race.
There’s also a clear geopolitical showdown between the U.S. and China. Some in government, including in the United States and allied nations, think we have too much economic entanglement with China and need to strategically decouple. This requires new industrial policy measures to boost domestic capacity or “friend-shoring” capacity with allies.
The pandemic was another big push. Rightly or wrongly, it created insecurity among policymakers that supply chains weren’t resilient. They think they will need more onshore capacity in case of a war or another pandemic, particularly in areas like pharmaceuticals and defense. There’s also been a change in the political climate, particularly in the United States, but also around the world. We’ve seen resurgent populism and a desire to boost the working classes. Industrial policy, via protectionism and subsidies, is a classic populist tool to help manufacturing, typically considered a working-class industry.
Finally, climate change has emerged as a significant driver for new policy measures by the government and academics. While a carbon tax would be the preferable approach, its political feasibility and practicality are questioned. As a result, alternative measures such as subsidies and tariffs are being pursued, partly to secure enough legislative support by appealing to domestic constituencies like labor unions and environmentalists.
When all of these factors are considered together, it becomes evident that they have collectively fueled a significant industrial-policy push over the past eight years.
Is the contemporary shift away from free trade due to a fundamental change in philosophy, or because exceptions are becoming so large they’re overshadowing the benefits?
I think it’s way more the latter, and I would push back a bit on the conventional wisdom, at least in trade-policy circles. Among trade economists and people who follow this subject closely, the conventional wisdom has always been that trade is 95/5 policy. Free trade is going to benefit about 95% of the population on net, give or take a few points here and there, but is going to impose concentrated costs on 5%, give or take. It’s an overwhelmingly beneficial policy on net but with concentrated costs for a very small minority of people. It’s really the mirror image of protectionism; because protectionism has concentrated benefits, again, for a very small minority of workers in, say, the steel industry, and of course, management and investors in the steel industry, but it’s going to hurt everybody else.
The other thing that was part of conventional wisdom is that even that 5% will eventually be better off for two reasons. One, trade is just part of an open and dynamic economy, part of that secret sauce for prosperity. Everybody benefits in the long term from having an open, dynamic, and prosperous economy, including the so-called losers from free trade. So you can think of free trade as the price of admission to a prosperous society. The other thing I think has been more challenging is the assumption that the dislocated 5% will adjust eventually. Yes, there will be short-term dislocations, but in the longer term–say, 10 to 15 years–the so-called losers from trade will find other jobs as long as you have a stable macroeconomic environment and a prosperous economy. In general, those jobs will be as good or better than the ones they left behind. So, there will be short-term costs, but eventually, they’ll diminish.
In general, the conventional wisdom is still correct, except perhaps when it comes to adjustment. We have seen a long string of literature, starting with the China Shock papers, showing that certain workers in certain places just didn’t adjust. They just didn’t move on. They didn’t move out of these distressed communities. They didn’t find other jobs or better jobs. They just kind of gave up, got on welfare, dropped out of the labor force or worked low-paying jobs. They were pretty ticked off about it all and that challenged the conventional wisdom and our politics.
In our political system, all you need is about 50,000 disgruntled people–i.e., a tiny share of the U.S. workforce of approximately 170 million people. If, however, they’re located in Pennsylvania and Wisconsin–or to a lesser extent, Ohio or Michigan–then you can flip a presidential election with that minority of votes. This dynamic can make protectionism politically attractive, despite being bad for most people and the nation.
The other part of the ignored conventional wisdom is that there have always been legitimate exceptions to a free-trade rule. The big one is national security, but there are other discrete ones, such as national emergencies, pandemics, etc, that may justify tariffs or subsidies in very narrow cases. But we recently had this perfect storm of events that happened in swift succession and caused the exceptions to broaden out and swallow the free-trade rule.
Starting with the Great Recession, there was a prolonged period of inadequate labor demand, labor-market slack, and economic insecurity that exacerbated the losses from trade. Those issues have amplified some of the populism that’s out there. The rise of China undoubtedly brought security-related issues to the forefront. China, again, in the 2010s embraced industrial policy, followed by President Xi Jinping cracking down on private business, which undoubtedly led more people to start thinking in protectionist or zero-sum terms.
Former President Donald Trump then comes along in 2016 and not only figures out how to leverage the 50,000 dislocated workers, but really removes a political check on free trade in the Republican Party. Since the 1990s–in Congress, at least–the free-trade contingent has been largely in the Republican Party. While Democratic presidents Bill Clinton, Barack Obama, and so forth were more or less globalist or free trade-ish, the real check on congressional protectionism and U.S. protectionism came from the Republican Party. After Donald Trump removes that check, a lot of Democrats are emboldened—classic, union-allied Democrats in the Chuck Schumer and Joe Biden mold–and believe they can pursue more of these policies.
When the pandemic hit the country, the empty store shelves and inability to get critical supplies created an emotional response that intuitively led to the belief that we need more protectionism and we need more onshore supply. That may be right or wrong, but it’s the political reality. So, you put all those things together, and you have a witch’s brew of events that have caused this general free-trade rule to be completely discarded and allow all of the exceptions and the politics to consume the rule. Now, the default is protectionism and onshoring, and free trade is really the exception.
Given the global shift toward protectionist policies following Russia’s invasion of Ukraine, to what extent should national security be an excuse for industrial policy?
Even free-trade ideologues like Milton Friedman or me: we acknowledge a national-security exception to a free-trade rule. There is certainly a case for not buying our tanks and planes from Chinese manufacturers. The same is true for legitimate national-security concerns, such as having an onshore supply of critical defense-related goods and other restrictions on services, digital trade, etc. The problem, however, is that it is supposed to be a narrow exception. In reality, the Ukraine invasion was just the straw breaking the camel’s back, rather than a real sea-change moment.
That being said, the national-security exception is real but routinely abused in almost comical ways. In the last few years, we have used national security to impose tariffs on completely non-security-related steel measures, including products like steel rebar or raw steel from our closest military allies. Putting tariffs on steel from our North Atlantic Treaty Organization (NATO) allies makes no sense, and it’s a complete departure from previous U.S. policy. That happened long before Russia invaded Ukraine; it was in 2018 under the Trump administration.
In the past, politicians have argued for sugar quotas on national-security grounds. We have Buy American restrictions on shoes and flatware for national-security-related reasons. There are many other such cases. Just recently, Sen. Rick Scott (R-Fla.) said that garlic from China was a national-security threat. So, these types of excuses are now swallowing the rule.
Moreover, we have turned a blind eye to the myriad problems that national-security protectionism inflicts, particularly on the very industries we aim to bolster. Beyond inefficiency issues and lower growth, national-security-related protectionism alienates our close allies and harms other U.S. industries. Any industry that consumes steel, which is a lot of defense industries, is now paying much higher prices than on the world market and thus is producing less, hiring fewer people, and investing less. This breeds copycat protectionism, where companies have incentive to claim that they are also vital to national security and deserve protection. We have also seen cascading protectionism in which tariffs on upstream products (steel inputs) lead to calls for tariffs for producers of nails, automobiles, etc., to offset the higher input costs.
Additionally, we’ve seen just lots of cronyism, if not outright corruption. There’s always a fine line between the two. As today, the way that you get out of paying tariffs is to hire a lobbyist, and you get an exclusion. When I was a practicing trade lawyer, I can’t tell you the number of times I had to tell American manufacturing clients that the best way to resolve their problem was to hire a lobbyist. And then, of course, this approach raises a whole host of other costs. Companies spend money on lawyers and lobbyists, instead of on their workers and innovation. That’s terrible for the very industries that you’re trying to protect.
While there may be some exceptions to free trade, we need to be mindful that they should remain exceptions. We should stay skeptical and be very mindful of the immense costs that these types of measures impose on the economy and on strategic industries.
What shortcomings of free trade do its defenders need to take seriously when advocating for it, especially considering the 5% who face dislocation and aren’t always taken care of, as previously assumed?
Free traders have made some missteps in the past, but critics have also given trade an unfair shake. In the ’90s and 2000s, government officials often oversold the benefits of trade and open markets, particularly regarding free-trade agreements. They claimed these agreements would produce amazing outcomes and even democratize China. Academics who studied trade, however, were never so pollyannaish; they maintained a more measured stance, arguing that free trade produces small but significant economic benefits and is part of the “special sauce” for prosperity. They recognized it as one of many good policies, not a silver bullet. We weren’t going to allow China to enter the World Trade Organization (WTO) and suddenly achieve world peace.
Moving forward, we need to develop a more realistic framework for understanding trade’s role in the broader economic landscape. Free trade is best understood as one tool in a larger economic toolkit. To foster a booming economy with a strong manufacturing sector, we need to consider a range of policies beyond trade liberalization, including tax, regulatory, and immigration policies. It’s not as simple as lowering tariffs and watching the magic happen. We must also acknowledge that, while we may have oversold the benefits of free trade, we undersold its disruptions. I disagree with the current conventional wisdom, however, that calls for more government involvement in helping workers displaced by foreign competition. Trade does create disruption, but that’s part of its benefit. We want a dynamic, open economy. Trade with Japan isn’t fundamentally different from trade between U.S. states or neighboring cities. It creates competition and disruption, which is generally good for overall economic health. We intuitively understand this until a national border is involved.
The key is recognizing that these disruptions contribute to our overall economic well-being, even if they cause short-term challenges for some sectors or workers. The focus should be less on giving hand-outs to those affected by disruption and more on helping them adjust to changes, whether these changes are trade-related, technology-driven, or due to shifting consumer preferences. As societies grow wealthier, we tend to buy more services than goods, necessitating economic adjustment.
While some left-leaning policymakers advocate for increased financial support for trade-affected workers through unemployment insurance or trade adjustment assistance, I believe this approach is myopic and misguided. General adjustment-assistance policies may have their place, but targeted protection or subsidies for trade-displaced workers will likely create bad incentives and prove ineffective. Instead, we need to examine how decades of government policies have made it difficult for people to adapt to disruptions.
In my book, “Empowering the New American Worker,” I explore various policy areas–housing, education, childcare, occupational licensing, and more–that have inadvertently hindered workers’ ability to adjust to changing economic landscapes. For instance, the lack of universal savings accounts makes it hard for families to save for unexpected changes. Our employer-tied health-insurance system, which is based on an outdated tax provision, limits job mobility. Expensive housing in thriving cities creates barriers to relocation. When disruption hits, it’s easy to blame the disruption itself. But we need to recognize how existing policies have made adjustment more challenging for American workers and families.
There’s a long list of government policy reforms that could help Americans adjust to economic disruptions, regardless of their source. This should be our focus. Even the China Shock literature, often cited by free-trade critics, doesn’t conclude that free trade is bad or that we need more protectionism. Instead, it raises the question: Why didn’t workers adjust?
While cultural and psychological factors are at-play, a significant reason is that we’ve made adjustment unnecessarily difficult through various policies. Simply throwing money at the problem or imposing more tariffs won’t solve this fundamental issue. The current critique of trade policy fails because it doesn’t adequately address the adjustment problem. It often misinterprets the China Shock literature as “China shock bad,” rather than “adjustment policy problematic.” This critique also ignores non-trade factors affecting workers and distressed communities, such as monetary policy and other economic influences.
By blaming trade for what is, in reality, a much more complex issue with multiple origins, critics oversimplify the problem. They suggest that fixing this one aspect will solve everything: prevent political upheavals, ensure economic stability, and eliminate future disruptions. This view is simplistic and fails to address the true complexities of our economic challenges.
Scapegoating trade for economic problems has become all too common. It’s an easy out for policymakers who’ve implemented ineffective policies. When workers struggle to adjust to economic shocks, it’s simpler to blame foreign competition than to acknowledge domestic policy failures. This isn’t limited to politicians; company managers and union leaders often fall into the same trap. But this blame game defies both economic literature and common sense. Contrary to popular belief, the United States is one of the least globally integrated economies in the world. When you look at imports and exports as a share of GDP, the U.S. ranks relatively low on the list. Trade is not the massive driver of the U.S. economy or its problems that some make it out to be; it’s just one piece of a much larger puzzle.
Yet the rhetoric from recent administrations, both Democratic and Republican, paints trade as the villain, claiming that decades of “free-trade fundamentalism” have led to some sort of neoliberal failure. For those of us who understand trade’s actual scale and impact on our economy, this kind of talk is frustratingly detached from reality. The magnitude of trade’s impact simply doesn’t align with the outsized blame it receives in political discourse.
Even today, surveys show that about 95% of economists believe free trade is beneficial. This overwhelming consensus can lead to complacency, with many assuming the debate is settled. But the case for free trade requires eternal vigilance. We must continually defend and justify it with data and substantive arguments, not just rely on the assumption that trade liberalization is an obvious good.
This complacency has been a significant issue for decades. Free trade wasn’t extensively studied or vigorously defended; it was often treated as a given, with people often trying to quickly move on to other topics. But in today’s political climate, we can’t afford to take the benefits of free trade for granted. We need to actively engage in the debate, armed with evidence and reasoned arguments, to counter the rising tide of protectionist sentiment.
