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A New ‘American Plan’ for Manufacturing

President Biden has proposed that the U.S. government invest billions of dollars in the pivotal U.S. semiconductor industry as part of an effort to assure continued global leadership. It is a break with 70 years of U.S. free-trade doctrine, as well as a huge step back to America’s future. This is a return to the […]

President Biden has proposed that the U.S. government invest billions of dollars in the pivotal U.S. semiconductor industry as part of an effort to assure continued global leadership. It is a break with 70 years of U.S. free-trade doctrine, as well as a huge step back to America’s future.

This is a return to the trail first blazed by Alexander Hamilton in 1791. Hamilton proposed mimicking Britain’s budding industrial revolution by copying its technology, imposing tariffs on imports of manufactures and providing financial incentives for the development of domestic manufacturing.

Hamilton was initially opposed by Thomas Jefferson, who dreamed of an America of yeoman farmers trading produce and raw materials like timber for imported manufactures. The outcome of the debate was determined by the War of 1812, which the U.S. nearly lost for want of manufacturing capability. In its wake, Jefferson yielded to Hamilton, noting that manufactures were “as necessary to our independence as to our comfort.”

The ensuing Tariff Act of 1816 launched a 132-year U.S. policy of imposing high duties on manufactured imports while subsidizing domestic industrial and technological development. Known as the “American System,” it led to the establishment of the Erie Canal, the telegraph, the transcontinental railway, and the world’s leading industries in steel, farm equipment, chemicals, autos, aviation, and engineering—along with the creation of the world’s largest economy by 1890 and the greatest economic mobilization ever seen in America’s World War II victory.

After the war, America ironically abandoned the American System and turned toward the Jeffersonian. There were two reasons. First, by dint of the American System and the nation’s victory in WWII, the United States had become the world leader in virtually every industry and no longer needed protectionist policies.

Second, many economists believed that U.S. tariff increases in the 1930s had both exacerbated the Great Depression and contributed to the outbreak of WWII. Led by the great John Maynard Keynes, they preached free trade as the road to both economic growth and peace. Thus was the postwar trading system founded in 1948 on free-trade principles.

It worked—for 25 years. During this economic golden era, GDP more than doubled. Dramatically rising productivity made it possible for single-earner families of eight like mine to enjoy middle-class life while sending the kids to college without borrowing.

By the mid-1970s, however, the United States began to experience trade deficits and balance-of-payment problems for the first time in nearly a century, as German Volkswagens and Japanese TVs showed up in American driveways and living rooms.

A shift away from the fixed-exchange rates of the 1948 system (4 Swiss francs or 360 yen per dollar, etc.) to floating rates (dollar value determined by daily trading in currency markets) temporarily stabilized U.S. trade. By the early 1980s, however, the deficits were back, suggesting that something more complex than exchange rates and low tariffs was at work.

Harvard economist Dani Rodrik notes that U.S. free-trade doctrine rested on questionable assumptions (e.g., permanent full employment) and ignored key realities like economies of scale (costs falling as production rises) and non-tariff barriers to trade (varying safety standards, monopolies).

Moreover, American economists and policymakers at the time assumed that all democratic, market-oriented economies operated with little government involvement. It was made brutally clear to me that this assumption was false when, in 1982 as Counselor to the Secretary of Commerce, I met with Naohiro Amaya, a major architect of Japan’s “economic miracle.”

Amaya explained that Japan did the opposite of what the American economists suggested. Because post-WWII Japan had an abundance of cheap labor, U.S. advisors recommended they make labor-intensive products like garments. However, the Japanese knew manufacturing industries with large economies of scale (steel, autos, etc.) drive productivity and higher standards of living.

Of course, at first it was more expensive to make steel in Japan than to import it from America. But the Japanese knew that as they produced more, costs would fall. To get there, they protected their markets — not with tariffs that would have violated free-trade rules, but by giving business leaders “administrative guidance” not to import. Japan also subsidized investment in manufacturing and eventually became a low-cost producer, dominating industries while the American trade deficit mounted.

Effectively, Japan had adopted the old American Plan. Later, the “Asian Tigers” followed suit. The clash between their own “American Plans” and modern America’s new free-trade doctrine caused friction and tears, but Washington never responded in kind because those nations were allies whose smaller economies posed no vital threat.

That brings us back to China, which has an American Plan with Chinese characteristics and is an entirely different story.

China is no ally, and by some measures, its economy is larger than America’s. The Economist rightly concluded in March 2018 that “the West made the wrong bet” in welcoming Beijing—with its “Made in China 2025” and similar industrial policies geared toward dominating global technology—into the World Trade Organization.

Must Biden re-embrace Hamilton and launch a full-fledged American Plan aimed not only at semiconductors but at substantial re-industrialization? Well, despite being the most productive part of the U.S. economy, manufacturing contributes only 11 percent to our GDP—much lower than Germany and Japan, where manufacturing is roughly 20 percent of GDP, and well short of China’s 30-percent mark. To prepare America to face the challenges of the future, Biden must aim for at least 15 percent.

Clyde Prestowitz is the author of The World Turned Upside Down: America, China, and the Struggle for Global Leadership and president of the Economic Strategy Institute.