Paradigm Shift?

I don’t do many evening events anymore, but last week I attended a dinner where the host put an interesting question: Is the Inflation Reduction Act (IRA) a one-off event or does it represent a paradigm shift in U.S. trade and economic policy?

There were people arguing both sides of that, and I took the negative side—that it is not a paradigm shift. My basic argument was one that readers of this column have heard before—that the United States has been pursuing industrial policy in various forms since Alexander Hamilton wrote about it in the late eighteenth century. Our government has long been willing to allocate resources to support innovation in areas deemed to be of national importance. I’ve cited past examples of agriculture in the second half of the nineteenth century, wireless communication after World War I, the space program beginning in the 1950s, and, more recently, the internet and GPS.

We don’t do it the way the Chinese do, which is by picking a specific company and giving them a specific task. The U.S. approach has been more market-based, funding a variety of research activities and seeing which ones bloom and are able to attract private investment, but the intended outcome is really the same—using government to create comparative advantage and stimulate economic activity that would not otherwise occur.

U.S. efforts have waxed and waned over the years, depending on the state of the economy and domestic politics. Liberal administrations have tended to support industrial policy, while conservative ones have viewed it as interfering in the market and picking winners and losers. The debate is complicated because there is no shortage of both winners and losers that each side can cite as proof of their position (Solyndra, I’m looking at you). Lately, there has been more bipartisan support for industrial policy because of concerns about China, something both Democrats and Republicans can agree on.

With that history in mind, I argued that the IRA is actually the culmination of a long history of U.S. government intervention in the economy and thus does not represent a paradigm shift, although the scale is certainly bigger than in the past.

As I thought about it more, however, I revised my opinion, because there is one part of what the Biden administration is doing that does represent something of a paradigm shift, and that is its emphasis on domestic content and domestic production. While the Buy America Act is not new (President Hoover signed it on his last day in office), for the first 80 or so years, it applied to U.S. government procurement, a large portion of which was for military use, and its actual economic impact was limited.

The Biden administration, however, has expanded the domestic procurement concept to put constraints on manufacturers receiving federal funds to build semiconductor plants (CHIPS and Science Act), to manufacturers of electric vehicles (EVs) and the batteries they use, and to consumers seeking to use tax credits to reduce their cost of buying EVs. The justification of this greater scope is national security. The United States needs resilient and secure supply chains in certain sectors for national security reasons (batteries) or to help achieve our climate goals (EVs).

To its credit, the administration has been—eventually—honest in acknowledging that these conditions require sacrifices in efficiency. (You may recall a recent column where I discussed Ambassador Tai’s comments about the need to sacrifice some efficiency in order to achieve other goals, which for her meant more equitable treatment of workers and greater inclusivity.)

This is the paradigm shift. Supply chain managers and corporate executive spent years looking for the best quality at the lowest price and the fastest delivery, in the name of maximizing efficiency and lowering costs. Now the administration is telling them they need to take into account another, noneconomic variable—resilience or security—as well. The result will be more security at the cost of less efficiency and higher prices.

From one perspective this makes sense. Covid-19 and other natural disasters demonstrate that having more secure supply chains is a good thing. China’s weaponization of its trade policy is forcing companies to reassess the risk of doing business there, with some of them deciding to re-shore or friend-shore. The problem is that while the lesson in these two cases is diversification—don’t put all your eggs in one basket—the IRA’s message is to go ahead and put them all in one basket; just make sure the basket is in the United States.

History will likely show, however, that that is a flawed strategy. Autarky is not feasible in a modern economy with complex supply chains as in semiconductors, so vulnerabilities will always remain. The United States is not immune from supply disruptions in the form of natural disasters—floods, tornados, plagues of locusts, etc.—and the efficiency costs will make us less globally competitive at the very time we need to be exporting more. The result may be that we end up less competitive without being more secure, and that we will do that by violating our international obligations as well.

So, there is a paradigm shift in terms of trading off efficiency for security, but as usual, we need to have a more serious debate about whether the juice is worth the squeeze.

William Reinsch holds the Scholl Chair in International Business at the Center for Strategic and International Studies in Washington, D.C.