Dim Bulbs

Monday, August 13, 2012
Obama and ice cubes
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Taylor Jones

Like the mythical Hydra—which grew two heads every time Hercules cut one off—President Obama, in both his State of the Union address and his budget, has defiantly doubled down on his brand of industrial policy, the usually ill-advised attempt by governments to promote particular industries, companies, and technologies at the expense of broad, evenhanded competition.

Despite his record of picking losers—witness the failed “clean energy” projects Solyndra, Ener1, and Beacon Power—Obama appears determined to continue pushing his brew of federal spending, regulations, mandates, special waivers, loan guarantees, subsidies, and tax breaks for companies he deems worthy.

Favoring key constituencies with taxpayer money appeals to politicians, who can claim to be helping the overall economy, but it usually does far more harm than good. It crowds out valuable competing investment efforts financed by private investors and it warps decisions through bureaucratic diktats susceptible to political cronyism. Former Obama adviser Larry Summers echoed most economists’ view when he warned the administration against federal loan guarantees to Solyndra, writing in a 2009 e-mail that “the government is a crappy venture capitalist.”

Obama and ice cubes

Markets function well when the returns are received and the risks borne by private owners. There are, of course, exceptions: governments have a responsibility to fund defense research and development and other forms of pre-competitive, generic R&D—for example, basic science and technology from nanoscience to batteries—but only when they pass rigorous cost-benefit tests and maintain a level playing field among alternative commercial applications.

For instance, the computer-linking technology that created the Internet was funded by the Defense Department for defense purposes. But, like numerous defense technologies, it wound up with commercially valuable civilian applications. Yet it would be foolish for the government to subsidize a particular search engine or social-networking platform.

“The government is a crappy venture capitalist,” Larry Summers laments.

The previous peak for U.S. industrial policy was in the 1970s and 1980s, when many Democrats wanted to emulate the then-growing Japanese economy by managing trade and directing specific technology and investment outcomes. Japanese subsidies mostly went to old industries like agriculture, mining, and heavy manufacturing. We now know that this misallocation of capital was one of the main reasons for Japan’s stagnation over the past two decades.

Industrial-policy fever waned after the 1980s, but never died. President George W. Bush expanded ethanol mandates and pushed hydrogen cars. Hydrogen’s use for transportation must still overcome combustibility concerns, or we’ll be driving mini-Hindenburgs. The Bush and Obama administrations bet big on ethanol and other biofuels, providing subsidies that distorted the global market for corn. The federal government was forced to drop its cellulosic ethanol quota by 97 percent last year because of a lack of viable biofuel refineries—and the quota still wasn’t met.

Even under optimistic projections, heavily subsidized wind and solar would each amount to a tiny fraction of global energy by 2030 and thus cannot be the main answer to energy-security or environmental problems. The short-run focus of most Department of Energy funding misses the main strategic imperative: we need alternatives that can grow to a significant scale over the long term without subsidies, and we need a lot more North American oil and gas in the meantime.

Obama is spending immense sums for subsidies to particular industries and technologies, almost $40 billion for clean-energy programs alone (some, appropriately, for generic technology that is not yet competitive). Yet a large number of prominent venture-capital funds are devoted to alternative-energy providers. They should be competing with each other and with the technologies they seek to replace—not for government handouts.

Meanwhile, the administration blocks shovel-ready private investment such as the Keystone XL pipeline from Canada to the Gulf Coast, which would create thousands of American jobs, increase energy security, and even improve the environment. The alternative is shipping the Canadian oil to China; we can refine it more cleanly than the Chinese, and pipelines are safer than shipping.

We need alternatives that can grow over the long term without subsidies, and we need a lot more North American oil and gas in the meantime.

America certainly has energy-security and possible environmental concerns that merit diversifying energy sources. More domestic oil and natural gas production will clearly play a large role. The hydraulic-fracturing revolution—credit due to Halliburton and Mitchell Energy; the government’s role was minor—is rapidly providing a piece of the intermediate-term solution.

The arguments to promote industrial policy—incubating industries, benefits of clustering and learning, more jobs, and so on—don’t stand up to scrutiny. Echoing 1980s Japan-fear and envy, some claim we must enact industrial policies because China does. We should remember that Presidents Lyndon Johnson and Richard Nixon wanted the United States to build a supersonic transport plane because the British and French were doing so. The troubled Anglo-French Concorde was famously shut down after a quarter-century of subsidized travel for wealthy tourists and Wall Street types.

Instead of an industrial policy that fails miserably to pick winners, a better response to foreign competition should be:

  • Remove our own major competitive obstacles. We can do this with more competitive corporate tax rates, more sensible regulation, improved K–12 education, and better job training for skills that the market demands, such as the computer literacy necessary even to operate today’s machinery. (Obama’s green-jobs training program spent hundreds of millions of dollars, but only 3 percent of enrollees had the targeted jobs six months later.)
  • Base trade and industrial policies on sound economics, not “insourcing” protectionism. If another country has a comparative cost advantage, we gain from exchanging such products for those we produce relatively more efficiently. If we tried to produce everything in America, our standard of living would plummet.
  • Pursue rapid redress for illegal subsidization and protectionism by our competitors. The appropriate venue for trade complaints is the World Trade Organization, not the campaign trail. We need to strengthen the WTO, not threaten its legitimacy with protectionist rhetoric that could spark a trade war.

Industrial policy failed in the 1970s and 1980s. Letting governments, rather than marketplace competition, pick winners and losers is just as bad an idea today. The Obama administration is responsible for the biggest outbreak of American industrial policy since President Jimmy Carter’s proposed $88 billion ($240 billion in 2012 dollars) synthetic-fuels program.

Carter was trounced in his 1980 re-election bid by free-marketer Ronald Reagan, who slashed marginal income-tax rates and regulations and lowered trade barriers. The result? The end of the “stagflation” of the Carter years and a return to strong economic growth.