China Is the Wrong Industrial Policy Model for the United States

This is the first commentary of a three-part series on Chinese industrial policy. The second will examine how to strengthen international rules and norms, and the third will discuss the question of how to restrain China’s distortive industrial policy practices.

The adoption of the CHIPS and Science Act is a watershed in U.S. economic policy. It is not because the United States has never practiced industrial policy before; in fact, the early development of semiconductors and the internet was due in large part to Defense Department support. And the U.S. federal and local governments have provided episodic aid for a variety of sectors and companies. It feels, though, as if a new era is beginning in which government support to strengthen the competitiveness of industries—for reasons of business, national security, public health, and the environment—will be seen as more necessary and normal than in the past. But as a new era dawns, it is important to get right both the goals and tools of industrial policy so that it is effective and consistent with international commitments. Otherwise, this change will leave the U.S. economy worse off than before.

The Right Goals

The United States needs to remember that it has not fallen behind China. The best overall measure of technology prowess is the Global Innovation Index. Even though China has been steadily climbing the ranks, the United States, at third, is still substantially ahead of China, at twelfth. Moreover, China’s rise has in part been propelled by a huge jump in patent filings and cited scientific papers, many of which are of low quality. If one looks industry by industry, although the Chinese have made great strides in information and communications technologies, mass transit (such as high-speed rail), life sciences, and a few others, there is almost no sector where China is the dominant technology leader, unlike the United States. Moreover, if one were to consider this “race” in terms of coalitions of likeminded countries, the United States and its Western allies from Europe and Asia are cumulatively even further ahead.

More important, the decision of whether to utilize industrial policy should be driven primarily not by whether the gap between the United States and China is narrowing, but by whether greater government intervention can produce more positive results than a more relatively laissez-faire approach for the country’s current needs. The United States does not need to “catch up”—the typical justification for industrial policy—but rather needs to accelerate an economic transformation for itself and the globe in an era when transnational cooperation for research, production, and consumption is less assured because of both geostrategic tensions and rising energy and transportation costs.

The Wrong Means

Equally important, although China’s recent progress is a motivating force for this shift, China’s state capitalist system is a bad model for the United States to draw on in determining how to proceed. In fact, it actually is often dysfunctional for China, too. There are at least four Chinese practices that the United States should avoid.

First, as CSIS documented in a recent study, the Chinese government spends an enormous amount on industrial policy . By the study’s calculations, in 2019 China spent the equivalent of 1.73 percent of its gross domestic product (GDP) in fiscal outlays, tax breaks, below-market credit, and other kinds of subsidies. Far back in second place was South Korea, at 0.67 percent of GDP. The United States spent only 0.39 percent of GDP. The study’s original estimate for China was extremely conservative; had the team modified its assumptions and included more components, such as government procurement (which was originally left out because of difficulty obtaining the requisite data), the Chinese figure would be closer to 4.9 percent of GDP, over 12 times the U.S. figure. Moreover, China is relatively indiscriminate about how it spends. Although the Made in China 2025 plan, issued in 2015, highlighted 10 industries, in reality Chinese industrial policy lavishes billions on dozens of sectors, with the hope that something will pay off. The result is a financial system ladened with debt that is mortgaging the country’s future. The United States should not see this difference as a “gap” that needs to be closed. America needs to lead in industries, not industrial policy spending.

Second, spending in China is heavily affected by political loyalties, not rational economic analysis. As a result, a disproportionate amount of industrial policy spending goes to inefficient state-owned enterprises (SOEs) and cronies. It should surprise no one that China’s push into semiconductors has been slowed by cash going to unqualified companies that dumped money into real estate projects as well as massive corruption in the firm managing the national semiconductor fund.

Third, China overemphasizes the development of shiny physical technologies that look good in photo ops. China’s achievements are displayed in tall skyscrapers, supercomputers, a space station, and new electric vehicles. But this preference for visible products has come at the expense of insufficient attention to the most important source of future economic growth—strengthening human capital. Millions of students in urban China graduate with degrees in science, technology, engineering, and math (STEM), but the educational system and overall political environment do not nurture creativity. For example, what lesson might China’s potential entrepreneurs take from the silencing of Alibaba founder Jack Ma? Equally important, even though absolute poverty has been reduced in rural China, educational attainment in the countryside, where over half of China’s youth live, is woefully inadequate. As a result, almost all of China’s recent economic growth has come from increased investment and essentially none has come from productivity gains, the source of true progress.

Fourth, China frames its industrial policy in highly nationalistic terms, a zero-sum contest pitting its own companies and economy against everyone else. This fear of external vulnerability has grown dramatically under Xi Jinping’s rule, as technological self-sufficiency, as opposed to raising China’s position in global value chains, has become China’s paramount industrial policy goal. The result is growing tensions with trading partners, particularly technology leaders, and slower growth due to pursuing strategies inconsistent with China’s comparative advantage.

The CHIPS and Science Act appears to avoid these four pitfalls. Its topline spending figure, $280 billion, is spread out over five years, so it will barely raise overall U.S. industrial policy spending as a share of the economy. Nor will it detract from the nimble U.S. financial system being the primary identifier and supporter of new technologies, industries, and jobs. Instead of indiscriminately throwing money around, support is focused on semiconductors and a small number of other critical technologies, such as energy storage, advanced computing, and nuclear physics. A great deal of attention in the new law is paid to developing talent through the U.S. educational system and workforce training. Foreign companies from likeminded countries, such as Samsung and TSMC, are fully eligible for investment support in semiconductor manufacturing. Although the law has several elements aimed at strengthening national security, the specific restrictions targeting China—making funding to companies conditional on their not investing in advanced chip manufacturing in China—seem narrowly focused to avoid massive disruptions in global supply chains and innovation networks.

Ensuring that this law and the other federal and local laws that will inevitably follow are implemented to maximize their benefits and minimize potential downsides will take continuous vigilance from Congress, the General Accounting Office, other executive branch agencies, the media, industry analysts, think tanks, and other countries.

Better Models

Although China provides lessons the United States should avoid, there are other economies that have done a better job of utilizing industrial policy in a more constructive manner. Chief among them are East Asia’s market democracies—Japan, South Korea, Singapore, and Taiwan. Although each has had its excesses that have generated substantial debt and substantial ill will with trading partners for discriminatory practices, their efforts have become more market-friendly and generated less friction with others as they have approached the technological frontier. They have also been able to make globalization and domestic job creation work hand in hand, thereby reducing the hollowing out of their manufacturing sectors.

A case in point is Taiwan’s emergence as the world’s dominant semiconductor manufacturing hub, accounting for well over 60 percent of the global market. This outcome was the result of a combination of three forces: (1) targeted financial and regulations to provide a nurturing environment for research and development, talent development, and dedicated manufacturing; (2) driven entrepreneurs able to mobilize resources and talent to develop a unique specialty (“pureplay” foundries, which are dedicated to producing chips designed by others); and (3) good timing (the rise of production costs in the United States and emergence of China as a key assembler in global information and communications technology supply chains) that permitted Taiwan to create this niche in the global economy. While the United States looks to strengthen its own chip fabrication capacity, it will also need, as Taiwan has done, to explore new technologies and business models that address critical needs and take advantage of emerging opportunities.

As the United States looks to extend its superpower status for future generations, although it should not attempt to “out-China” China, it could do worse than to draw from the experiences of smaller successful counterparts who have pursued industrial policies characterized by their relatively humble ambition and creatively managed resources.

Scott Kennedy is senior adviser and Trustee Chair in Chinese Business and Economics at the Center for Strategic and International Studies in Washington, D.C.

Commentary is produced by the Center for Strategic and International Studies (CSIS), a private, tax-exempt institution focusing on international public policy issues. Its research is nonpartisan and nonproprietary. CSIS does not take specific policy positions. Accordingly, all views, positions, and conclusions expressed in this publication should be understood to be solely those of the author(s).

© 2022 by the Center for Strategic and International Studies. All rights reserved.

Scott Kennedy
Senior Adviser and Trustee Chair in Chinese Business and Economics