The United States is a global leader in manufacturing, containing only 4 percent of the world’s population but producing 18 percent of the world’s manufacturing output. Yet recently, the rise of China as a global power—and as the world’s largest manufacturing producer—has spurred calls for government intervention to increase U.S. competitiveness.

Congress and the Biden Administration both responded with proposals for massive new government investment. Unfortunately, this type of industrial policy would likely have unintended consequences that reduce U.S. competitiveness. Instead, Congress should address current challenges faced by U.S. manufacturers: tariffs on over $260 billion of imported goods used in American production, and growing regulatory burdens that prevent manufacturers from investing in productive expansions.

Background

Last month, the Senate passed the U.S. Innovation and Competition Act, a bill that would trigger roughly $245 billion of new direct government spending and appropriations for a variety of purposes, including semiconductor manufacturing, 5G development, and increased funding for the National Science Foundation. The House shortly followed suit by passing two bills to increase funding for the National Science Foundation and Department of Energy’s Office of Science. Similarly, President Biden’s American Jobs Plan proposes over $400 billion of government funding for domestic manufacturing, research, and development.

While concerns over China’s rise may be well-founded, a lack of funding for U.S. research and development is not the issue. Annual R&D expenditures have been steadily rising on an inflation-adjusted basis ever since the National Science Foundation first started tracking them in 1953.[i] Private companies spearheaded that growth, with nearly three-quarters of the rise in R&D over the last two decades driven by increases in business investment.[ii]

Furthermore, concerns that the U.S. manufacturing base is shrinking are unfounded. While manufacturing employment in the United States has declined, this downward trend has occurred worldwide as technological innovations increased productivity. U.S. manufacturing output, on the other hand, has trended upward even as employment has dropped. The United States remains one of the most productive manufacturers in the world.

The Harms of Industrial Policy

Massive government investments in domestic production would have unintended consequences that harm U.S. manufacturing and the economy. One analysis of past industrial policy efforts found that these initiatives have come with significant costs. The projects themselves often cost more than the initial projections, they impose opportunity costs in the form of forgone investment alternatives, and the tax increases used to fund the new spending slow economic growth. Evidence also shows that government industrial policy crowds-out private dollars that would have been invested in more productive and timely ways.

Additional research finds that government industrial policy spending tends to favor businesses that are more politically connected and those engaged in heavier lobbying as opposed to investments that maximize consumer welfare. Furthermore, government-planned investment often takes years to execute, after which time new innovations may render those investments obsolete. According to one review of Europe’s industrial policy efforts, “many of these initiatives were either short-lived, faced multiple delays, or offered no innovation in the market they entered.” Similarly, Japan’s industrial policy resulted in multiple government planning failures, corruption, and an economic collapse that launched Japan into its lost decade.

A Better Way to Boost Competitiveness: Decrease the Cost of American Manufacturing

A better way to boost U.S. competitiveness relative to China would be to remove current barriers to American production. For instance, tariffs imposed during the last administration continue to increase costs for American producers, and a growing number of regulations continue to impose significant costs on manufacturers.

In 2018, the United States imposed new tariffs to protect domestic aluminum and steel manufacturers under Section 232 of the Trade Expansion Act of 1962. Additional tariffs, imposed under Section 301 of the Trade Act of 1974, were later levied on nearly three fourths of U.S. imports from China.[iii] These tariffs reduced domestic manufacturing output relative to projected levels.

The tariffs were initially imposed to boost American manufacturing by increasing the cost of foreign-made goods relative to domestically-produced goods. Yet, because the tariffs were also imposed on intermediate and capital goods used in domestic production, their actual effect is to also increase costs faced by U.S. manufacturers. Table 1 details the total value of these goods, showing that the tariffs impact nearly $260 billion of inputs used in American manufacturing and impose an annual tariff burden of $40 billion on U.S. producers.

Table 1: Manufacturing Imports Subject to Tariffs: Intermediate Inputs and Capital Goods[iv]

 

The $40 billion annual tariff burden represents the entire upward pressure placed on import prices in American manufacturing. The only way American producers would not face this price increase is if China lowered the price of its exports to the United States to offset the cost of the tariffs. Unfortunately, this is not the case, and the preponderance of evidence suggests American importers are paying nearly the entire cost of the tariffs.[vii]

Faced with these higher costs, American manufacturers are suffering. At the onset, thousands of businesses applied for tariff exclusions claiming they are unable to find alternative sources for these goods and would suffer severe economic harm from the tariffs. Those unable to obtain exclusions were forced to absorb the tariff burden by reducing future investments or employment, or pass the costs on to the purchasers of their products.

Semiconductor manufacturing provides an example. By increasing the cost of parts, such as semiconductor chips made in China, the tariffs led to fewer chip imports and a resulting decrease in U.S. semiconductor production. In effect, the tariffs are contributing to current semiconductor shortages—a manufacturing sector the Senate explicitly aims to bolster with its legislation. 

Tariffs are also harming manufacturing workers. While a small number of manufacturers benefited from the protectionism—those that produce exactly the same goods as the imports subject to tariffs—a larger number of manufacturers and businesses in other sectors of the economy, like construction, were harmed by rising input costs and forced to reduce their workforces. One study predicted that steel and aluminum tariffs would cause more than five job losses for every one job gained, and additional estimates suggest that the steel and aluminum tariffs depressed manufacturing employment by 75,000 jobs in the year after their enactment. These estimates do not consider the additional harm to manufacturers caused by retaliatory tariffs, which are still being levied on over $76 billion of annual U.S. exports.

Regulations also have the impact of raising the cost of production and decreasing U.S. competitiveness. In the decade before 2020, the federal government imposed an average of 360 new regulations each year. This regulatory burden has increased significantly over time: In the 1950’s, the federal government published an average of 18,000 pages in the federal register annually, which has grown ten-fold to an annual average of 180,000 pages today.[viii]

The growing regulatory state is especially harmful for U.S. manufacturing. One estimate suggests that, since 1981, the federal government has imposed at least one new regulation on U.S. manufacturers each week, and that today manufacturers face nearly 300,000 restrictions on their operations due to federal regulations. Another study finds that the average manufacturer pays over $19,000 per employee per year in regulatory compliance costs. Smaller manufacturers are disproportionately burdened, as those with less than 50 employees face an average annual compliance cost $35,000 per worker.

Reducing this regulatory burden would allow producers to invest their cost savings in ways that increase productivity and benefit workers. When asked how they would spend funds currently allocated to regulatory compliance if their costs were reduced, one survey revealed that 63 percent of manufacturers would invest the funds to grow their business operations, and 22 percent would invest in their workforces.

Is Government Intervention Worth It?

The Congressional Budget Office (CBO) estimates that it will take 10 years to fully implement the $245 billion of direct spending and other appropriations authorized in the U.S. Innovation and Competition Act. A decade from now the U.S. technology industry could look dramatically different, and the investment priorities laid out in the Act may no longer be relevant. For context, ten years ago Netflix was still mailing disks direct to homes and Nokia held one third of the U.S. market share for smartphones.

Even if the government investments are still relevant and valuable in a decade, they will not be enough to counter the harm to manufacturing caused by remaining tariffs and rising regulations. In the next 10 years, based on 2020 import levels, current tariffs on inputs to production will cost U.S. manufacturers around $400 billion.[ix] And if the prior ten years are any indication, increasing regulations could impose at least an additional $740 billion of costs on the economy.

Instead of trying to counter China’s rise with new government interventions, the United States could consider joining a multilateral trade agreement to reduce global dependence on China. The Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP), for example, is a trade agreement between Japan and ten other nations in the Indo-Pacific that currently excludes China. While the agreement was originally designed to counter China’s growing influence, reports suggest that China is now interested in joining—a move that would solidify China’s power in the region. If the United States were to join the CPTPP or other trade agreements with countries in the Indo-Pacific, not only would preferential tariff treatment boost U.S. exports, but the agreement would also increase America’s influence on the rules of global commerce. This could potentially encourage China to change its unfair trade practices—a goal that tariffs have been unsuccessful at accomplishing.

Jackie Varas
Senior Economist