Causality and China

Causality and China

Samuel Gregg

Since 2015, much of my time has been spent debating some of my fellow conservatives who believe that the U.S. economy requires more active state intervention to address various challenges facing America. Over the subsequent seven years, that discussion has only intensified. This is reflected in the responses offered by Aaron M. Renn, Patrick T. Brown, and Iain Murray to my argument that it is through greater entrepreneurship and enhanced competition that America is more likely to realize a broad-based economy.
Causality and China
One advantage of debating people over a lengthy time period is that you start recognizing patterns in how they state their views. In the case of those conservatives pushing for greater state economic intervention, one noticeable tendency is the habit of making broad statements—“America has deindustrialized!” “We’re outsourced millions of jobs to Mexico!” “China shows that industrial policy works!”—that, on closer examination, turn out to be at variance with the evidence.
This inclination characterizes much of Aaron M. Renn’s response to my argument that interventionist policies are a sub-optimal means for realizing a more broad-based American economy. Let me focus on just two of his claims which exemplify the problem before addressing Brown and Murray’s contributions.
In reply to my argument that the Federal government had little to do with the creation of the Internet, Renn states: “the US government created the Internet.” To support this assertion, he argues that the Internet’s deepest roots lie in the government’s investment in electronic warfare during World War II. This, Renn holds, helped establish Silicon Valley, a process accelerated by preferable regulatory treatment accorded to the tech industry.
The problem with this argument is that it does not establish causality. Think about it this way: No one in the U.S. government said to themselves in the 1940s, “Let’s get better at electronically targeting Germany and Japan’s military assets and, as a side-effect, create a high-tech industry.” One may as well state that the Internet’s real beginnings are to be found in Thomas Edison’s opening of the first electrical power plant in 1882 or the first use of algorithms in ancient Babylon.
This question of causality is a perennial problem with industrial policy. As a 1993 World Bank assessing industrial policy’s contribution to the East Asian economic miracle famously stated: “It is very difficult to establish statistical links between growth and a specific intervention and even more difficult to establish causality. Because we cannot know what would have happened in the absence of a specific [industrial] policy, it is very difficult to test whether interventions increased growth rates.”
Compounding the problem with Renn’s arguments is that, like many industrial policy advocates, he conflates defense policy and industrial policy. Industrial policy is specifically concerned with making selective interventions into the economy with the goal of realizing a different set of outcomes than would otherwise be delivered by markets. But this is not the objective of military R&D. Governments promote such research to help secure national security. There may be spillover effects, but neither these nor the uses to which they might be put can be known in advance.
These distinctions demonstrate that one cannot establish a straight line between the activities cited by Renn and the Internet’s emergence. A little history further underscores the point.
If the Internet has a direct forerunner, it was the Advanced Research Projects Agency Network (ARPANET). This was created by a U.S. Defense Department agency as a military-networking device for government agencies and university researchers. But as economist Adam Thierer illustrated in his book Permissionless Innovation, it was not until the Clinton Administration permitted open market commercialization of this technology—i.e., a policy directly at odds with the targeted approach that characterizes industrial policy—that the Internet became possible. Thus, while ARPANET did have unintended spillover effects, it is a stretch to say that the decision to create it led directly to the Internet.
A second example of a bold claim insufficiently supported by evidence concerns Renn’s reflections on how trade with China has affected America. According to Renn, “trade with China had caused many American job losses. We tried free trade, and many if not most Americans are right in concluding that it did not work out well for them.”
Certainly, America’s relationship with China has changed in the wake of Beijing’s abandonment of the late Deng Xiaoping’s policy of “hiding strengths, biding time, never taking the lead” to prevent China’s rise as a global power from spooking the globe. Under Xi Jinping, China has adopted a more belligerent tone in foreign policy, increased its military activity and spending, and tried to realize aggressively some of its regional and international ambitions. Obviously, this turn is not in America’s interests.
But who are these Americans for whom freer trade relations with China, according to Renn, did not work out so well? Is it the 330 million Americans (especially poorer Americans) who benefited from substantially lower prices for consumer goods over a considerable period of time? Is it the thousands of American businesses that gained wider access to a market of 1.4 billion people? Could it be the millions of American workers employed in industries (logistics, transportation, etc.) involved in the export and import of millions of goods between America and China? Has it been the American companies spurred on by Chinese competition to innovate, become more efficient, and improve their international competitiveness and wealth-creation capacities?
By “job losses,” Renn most likely has in mind the decline in U.S. manufacturing jobs. Yet he neglects to mention that, as Pierre Lemieux points out, the proportion of civilian employment in manufacturing attained a peak of 26 percent in 1953—i.e., 25 years before China tentatively started opening its economy to the world in 1978—and has since fallen non-stop to 8 percent in 2016.
We also know that between 1999 and 2011 about 1 million of the 5.8 million manufacturing jobs lost in America following the “China Shock” disappeared as some American manufacturers failed to adjust to compete with Chinese imports. In other words, 4.8 million manufacturing jobs disappeared for reasons other than trade with China. Somewhere between 80 and 90 percent of manufacturing job losses in this period resulted from technological advances and process improvement. It follows that even if China had not entered the WTO in 2001, American manufacturing jobs would still have undergone substantial decline because of technological and process enhancements.
The questionable claims about China, however, do not stop there. Renn states, for example, that “Given its status as the premier case study of economic growth and transformation today, it’s curious that Gregg does not explain why we could not learn from China.”
I think that there are many things that America could learn from China beyond the poverty-reducing effects of openness to global trade. We might learn, as the economist Barry Naughton demonstrates in his book The Rise of China’s Industrial Policy, 1978–2020, that China’s breakthrough economic developments prior to 2008 owed almost nothing to industrial policy. Industrial policy-like interventions are far more a feature of post-2008 China.
An associated lesson from China’s turn to the state after 2008 to maintain the pace of economic development is that the results have generally been mediocre and often counterproductive. Industrial policy Chinese-style has, for instance, resulted in colossal failures in areas like the production of semiconductors, electric vehicles, domestic aircraft and automotive manufacturing industries, and 3G mobile technologies. Other broader problems to which industrial policy has contributed in China include:
Widespread corruption in major economic sectors like banking and R&D.
Extensive misallocations of capital across the economy. Even Chinese government officials have conceded that Beijing blew at least $6 trillion on ineffective investments between 2009 and 2014 alone.
The development of overcapacity in industries like solar panels, steel, cement, and aluminum: i.e., the creation of too many goods that will most likely never be purchased.
The growth of investment bubbles in many targeted industries and an increasing number of non-performing commercial loans.
In this light, one lesson that Americans can certainly glean from China is that industrial policy seriously hurts those nations which deploy it. Why would America want to go down such a path?
There is nothing “simplistic” about adopting the entrepreneurship-and-competition path as the way forward for the American economy. It not only requires a sophisticated understanding of problems, but also demands the courage to act.
“We Have to Do Something”
Patrick T. Brown’s contribution to this forum reflects different emphases than Renn’s. Brown acknowledges, for instance, some of the deep problems with industrial policy, including the chronic cronyism that it breeds and which most industrial policy advocates simply shrug their shoulders about.
Nevertheless, Brown insists that the government cannot be idle in the face of different social challenges that he associates with the processes of economic liberalization. This theme pervades the writings of many self-described common good conservatives.
The state certainly has concrete responsibilities vis-à-vis the common good. But effective government action requires an accurate understanding of the problem being addressed. Herein lies the weakness of Brown’s position.
Like Renn, Brown refers to those several million jobs that disappeared from the manufacturing sector and he stresses the social costs associated with this. According to Brown, “the political effects of perceived stagnation in Indiana are not ameliorated by pointing to the success of poverty alleviation in India.”
This claim, however, downplays the fact that most of the American towns that fall into this category have in fact adjusted and are not stagnating. For example, of the 185 U.S. counties in America’s Northeast and Midwest identified as having a disproportionate share of manufacturing jobs in 1970, approximately 115 had managed to switch successfully away from manufacturing by 2016. Of the other seventy, forty had exhibited “strong” or “emerging” economic performance between 2000 and 2016.
Yes, this process took time. Nor was it easy. But adjustment has for the most part occurred. Moreover, as I mentioned in my original essay, it is hard to find examples of industrial policy reversing decline in communities especially reliant upon particular forms of manufacturing. Even Trade Adjustment programs, as Brown himself notes, are generally ineffective. Indeed, I would add that there is considerable evidence that such policies incentivize people not to adjust.
Brown’s wider point is that we need a more Burkean approach to matters like trade policy. He interprets this as meaning that “we give greater deference to [liberalization’s] potential impact on towns and families, instead of racing headlong into a future where greater liberalization would solve the problems it itself was creating.” In the past, he says, “the concerns of manufacturing workers, and the communities they used to be the backbone of, were undeniably given short shrift.” That, Brown argues, must change.
There are two difficulties with this argument. One concerns Burke himself. Burke’s approach to trade was (as I’ve detailed elsewhere) to push the pendulum towards liberalization as far as political conditions permitted. Burke didn’t spend much time wondering whether such liberalization would hurt families and undermine town life. In later life, Burke wrote in his Letter to a Noble Lord that he would have liked to have gone further in pushing for the expansion of commercial liberty “if more had been permitted by events.” For, like his friend Adam Smith, Burke was convinced of the long-term economic and non-economic benefits for individuals, families, communities, and nations of greater economic freedom.
Instead, Burke’s gradualism reflected his awareness that advancing wider trade freedom involves overcoming deep resistance to expansions of economic liberty. Burke understood (like Smith) that policies like trade restrictions and subsidies usually have nothing to do with the common good and everything to do with politically-connected groups trying to protect their privileges or secure more largesse from the state. Diminishing such resistance means negotiation and deal-making to achieve the wider goal of prying open hitherto closed markets.
This brings me to the second problem with Brown’s argument. He appears not to recognize that Burkean-like approaches to trade liberalization have been the norm since World War II. We have long lived in a world in which trade liberalization is characterized by endless intergovernmental negotiations that give enormous deference to the possible side-effects of reductions in protectionism upon numerous communities and interests: so much so that it is a wonder that anything is agreed upon at all.
Such negotiations typically cover subjects ranging from what tariff levels will be applied to various goods, to what will be each participating country’s minimum wage. They involve nations agreeing to adopt laws affecting matters as particular as working hours, food-safety standards, patents, environmental regulation, and immigration. Moreover, while they are negotiating such things, all governments are heavily lobbied. Whether it is trade unions or particular industries, they all want provisions written into trade agreements that they deem necessary to protect their interests. That’s why such agreements are typically thousands of pages in length. Put simply, the gradualness for which Brown calls vis-à-vis liberalization already exists—and it is the gradualness of a snail.
A Conservative Alternative to Conservative Interventionism
A quite different perspective is brought to bear upon these questions by Iain Murray. His focus is on an important question, the answer to which helps determine whether an entrepreneurship-and-competition approach has any chance of contributing to the development of a broad-based economy. That question is: how does the regulatory state figure into this discussion?
Murray reminds us that regulatory agencies’ expansionary view of their own powers means that “Any industrial policy will be coopted by bureaucrats and rent-seeking companies toward their own ends. That lack of accountability means that regulators will always choose to use power delegated to them in ways that favor their own interests—and rent-seekers will always look for ways to exploit the situation.” He then lists numerous cases which illustrate the point.
These facts alone should make anyone skeptical about industrial policy. Murray adds, however, that the same regulatory state is normally predisposed against any significant expansion of economic freedom. Murray then illustrates the myriad ways in which regulatory agencies and the administrative state more generally seek to limit entrepreneurship and actively curtail competition.
These facts point to a hard conclusion: that if entrepreneurship and competition are to play the role that I think they should in America’s economy, the prerequisite is, as Murray puts it, “nothing less than a wholesale program aimed at eliminating the administrative state as it exists today.”
Therein lies an economic project worthy of conservatives, and one with immense potential to bolster America’s common good. Yes, the modern regulatory state has been around a long time and it seems only to grow. It is also bolstered by the many Americans—government employees, crony businesses, lobbyists, legislators etc.—whose livelihoods and power depend significantly upon the administrative state remaining firmly in place.
But the future of conservative economic policy surely cannot lie in effectively giving aid and comfort to such people and their private and public enablers—let alone simply accepting the status quo. Nor can it be with those conservatives who insist that, if only they were in charge, the administrative state could be redeployed to good ends, or that their particular industrial policies would somehow magically overcome all the well-documented problems that manifest themselves wherever industrial policy has been tried, whether in China, Europe, or Japan.
Of course, taking down the regulatory state should not be the entirety of a renewed conservative economic program. Restoring entrepreneurship and competition to their proper place in America also involves: 1) putting the Federal government firmly back within its constitutionally-defined limits; 2) the restoration of sound monetary policy; 3) fixing our bloated and chaotic tax code; 4) reforming our dysfunctional immigration laws; 5) stronger protection of property rights; and, above all, 6) strengthening the rule of law in a country where it is visibly weakening.
Such tasks remind us that there is nothing “simplistic” (to use Renn’s expression) about adopting the entrepreneurship-and-competition path as the way forward for the American economy. It not only requires a sophisticated understanding of the aforementioned problems, but also demands the courage to act: something not especially characteristic of America’s political class at the best of times. The alternative for conservatives, however, is to acquiesce to economic mediocrity and the ongoing politicization of American economic life that remains core to the left’s view of the world. And for conservatives who care about America, that is no alternative at all.

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