Industrial policy was once so out of fashion that it was jokingly called “the policy that shall not be named.” Now it’s back in a big way. On issues ranging from clean energy to semiconductors to Covid-19, governments are trying to improve the performance of key business sectors. Can they manage to do so without subverting competition and subsidizing special interests?
This article is part of ProMarket‘s series on industrial policy. Stay tuned as we publish an article each week this quarter on the topic.
President Donald Trump, not Joseph Biden, is to blame for reversing 90 years of presidential leadership to instill market forces in the world economy. On his second day in the Oval Office, Trump withdrew the United States from the Trans-Pacific Partnership (TPP) and followed with four years of bombast. Trump derided the World Trade Organization (WTO) as an institution “created to suck money and jobs out of the United States,” increased tariffs on solar panels, washing machines, steel and aluminum, and launched a trade war with China.
Compared to Trump, Biden exudes sweet reason, but his trade policies are equally harsh. Biden has reversed Trump in many arenas, but on trade protection Biden has doubled down. Like Trump, Biden seeks to boost U.S. manufacturing through more stringent “Buy American” requirements and subsidies to select firms. Trump’s fake “national security” tariffs still enlarge steel profits with only small concessions to allies, and the China trade war, with technology embellishments, now enters its fifth year. Biden made no attempt to rejoin the TPP, and the new “trade” pacts he proposes—the Indo-Pacific Economic Framework (IPEF) and the Americas Partnership for Economic Prosperity (APEP)—don’t offer signatories preferential access to the U.S. market. Indeed, in most respects, Biden is either continuing or enlarging the protectionism of the Trump era.
This protectionism has real costs. Tax dollars are wasted on a huge scale; the United States no longer charts the path of the world economy; and foreign markets are foreclosed to U.S. exports. Other countries recognize those costs and will continue to pursue an open world economy, with or without U.S. support.
“Buy American” and the Inflation Reduction Act of 2022
In his State of the Union address on February 7, 2023, Biden announced a more extensive “Buy American” policy, requiring “all construction materials used in federal infrastructure projects to be made in America” with “American-made lumber, glass, drywall, fiber optic cables.” The new provisions are meant to close an imagined decades-long loophole in the Buy American Act of 1933 that restricts domestic procurement to iron and steel in funded infrastructure projects. Once finalized, the new provisions will extend coverage beyond iron and steel to include all construction materials and will apply to “virtually all infrastructure spending supported by Federal financial assistance,” including not just roads and bridges, but also buildings, water infrastructure, and high-speed internet.
Biden has been a staunch supporter of Buy American since assuming office and frequently incorporates Buy American provisions or incentives to boost U.S. manufacturing via domestic sourcing into major legislation. For example, the Inflation Reduction Act (IRA) of 2022—a landmark $369 billion health, climate, and tax law—offers a tax credit of up to $7,500 for buyers of new electric vehicles (EVs) if materials for EV batteries are sourced in either the U.S. or one of its free trade agreement partners and if the EV is assembled in North America. Topping off those statutory requirements, Biden declared that all materials for the full range of IRA projects—everything from wind turbines to solar panels for charging stations—must be made in America. Unsurprisingly, the IRA excludes the EV output of many U.S. trade partners, including France, Germany, and South Korea, either because they don’t have free trade agreements with the United States, or because electric vehicles must be assembled in North American plants. Buy American provisions in the IRA echo those already imposed, through Biden’s order, on roads, bridges, and transmission lines built under the $550 billion Bipartisan Infrastructure Investment and Jobs Act of 2021.
The Costs of Buy American
Buy American translates into prohibitive tariffs. Even for the huge U.S. economy, consequences are severe, owing to the nature of affected merchandise. If Buy American applied to consumer goods such as automobiles and furniture, made by at least a dozen domestic firms, the price markups from excluding imports might reach 15 percent—painful but not exorbitant. Competition between domestic firms would limit the cost to consumers. Owing to a decent number of domestic firms, forbidden imports could be replaced within six months or sooner.
But the market characteristics of merchandise subject to Buy American are utterly different than the market characteristics of most consumer goods. Big ticket military hardware, like fighter jets and ships, are one extreme. These are made by only two or three U.S. firms, and contracts are typically renegotiated to compensate for cost overruns. The final price and time to completion customarily exceed launch plans by a factor of two or more. Such costs and delays are accepted as the price of national security.
The market characteristics of infrastructure more closely resemble military hardware than consumer goods. Often only a few firms have the connections, technical skills, and capacity to construct highways, bridges, tunnels, wind farms, solar farms, and broadband networks. This is the outcome of burdensome permitting requirements and geographic specificity of infrastructure projects. In turn, each successful contractor requires dozens of unique components to complete the task. By excluding foreign contractors—even technically qualified firms based in allied countries such as Canada and Korea—competition is quashed at the outset. Then, by denying U.S. contractors from acquiring scarce components from foreign sources, delay is guaranteed. President Biden invokes Buy American not in the name of national security, but in the name of jobs, jobs, jobs—notably at a time when unemployment has reached a 50-year low of 3.4 percent, and almost two job vacancies exist for every American looking for work.
Responding to the Great Financial Crisis of 2008-2009, President Obama signed the American Recovery and Reinvestment Act (ARRA) of 2009. Among other features, the ARRA contained a strict Buy American requirement for structural steel in transportation and water projects. Careful analysis showed that the requirement increased steel costs by about 40 percent (see Chapter 9 of Local Content Requirements: A Global Problem). As Obama himself later acknowledged, many ARRA projects were not “shovel ready,” for which Buy American delays were one cause. President Biden’s latest Buy American mandate reaches far beyond steel to cover all materials and components for the vast range of projects launched by the IRA.
One estimate suggested that, in 2020, the cost imposed by Buy America on U.S. public procurement, then $1.7 trillion, amounted to $94 billion annually. The implied tariff equivalent creating this cost was 26 percent. (Notably, the European Union is far worse in the domain of local content requirements (LCRs). The EU incurs $471 billion extra costs from its own LCRs on $2.7 trillion of domestic procurement, with a tariff equivalent of 117 percent.)
Friction with Allies
Two aspects of Biden’s 2022 legislative successes have triggered considerable friction with Europe, Japan, and Korea. The CHIPS and Sciences Act of 2022 commits $76 billion to U.S. semiconductor R&D and production, whether by U.S. or foreign firms. EU officials, fearing that the U.S. lure will foreclose European semiconductor production, are enacting their own array of subsidies. Japan and Korea harbor similar concerns but are less vocal. Meanwhile, Samsung and TSMC are building major semiconductor plants in Texas and Arizona, respectively.
Protectionist provisions within the IRA preclude many U.S. allies from exporting needed materials. Their reactions are no surprise: first, they rebuff any U.S. call to lower their own trade barriers or temper their industrial subsidies, and second, they reach out to countries elsewhere in the world that still see the payoff from freer trade and investment. As long as Biden and his successors insist on maximum Buy American requirements, the U.S. has no chance of opening potential foreign export markets covered by even stricter LCRs.
The Twilight of U.S. Economic Leadership
In the geopolitical arena, Biden is not shy about proclaiming American leadership. The economic arena is a different story. By imposing fake “national security” tariffs on steel and aluminum, by launching a trade war with China, and by threatening to walk away from NAFTA and the WTO, Trump revived protectionist policies last seen at the onset of the Great Depression. With less noise, Biden not only continued Trump’s policies, but doubled down. U.S. economic leadership has depreciated into “All Hat, No Cattle”—the Trade and Technology Council (TTC) with Europe, the Indo Pacific Economic Framework (IPEF) with Asian friends, and the Americas Partnership for Economic Prosperity (APEP) with Latin America.
Confronted by aging infrastructure, climate change and China, U.S. leaders have embraced industrial policy on a massive scale: the Bipartisan Infrastructure Act, the CHIPS and Sciences Act, and the Inflation Reduction Act. The history of U.S. industrial policy episodes since 1970 indicates that R&D intensive projects, and projects open to foreign competition, have a better track record. Yet this latest embrace is accompanied by strict Buy American requirements and only a modest boost to R&D.
From President Franklin Roosevelt to President Barack Obama, the United States promoted an open world economy based on market principles. Many countries, even including China, followed the American lead. “Globalization” may have become an American pejorative, but it delivered spectacular world growth from 1950 until 2010. Even as the United States strays from the tenets of an open world economy, other capitals still see the wisdom of continuing the course—but without Washington at the helm.
The authors are associated with the Peterson Institute for International Economics in Washington DC. Views expressed are their own.