Stories to Watch: Industrial Policy

Government misallocation of resources

Part of my personal mission is to try to stay out of daily online conflicts and instead contribute something to long-term understanding. There are plenty of ongoing stories to which I think I can contribute some perspective. One is the long-term fiscal position of the U.S. government. Another is the potential for the political divide in this country to escalate, with both sides taking to the streets. Yet another is how things will play out with what we are calling artificial intelligence (large language models).

The story I want to introduce here is the potential for industrial policy to misallocate resources. The attempt by government to use powerful carrots and sticks to increase domestic factory capacity and to move toward renewal energy sources could work out very well. You can read Noah Smith for the enthusiastic case.

I think it is going to be a disaster. From my perspective, which is that of a free-market economist, everything about the CHIPs act, the Inflation Reduction Act, and their ilk, sets off alarm bells.

Of course, the private sector is capable of misallocating talent. Consider the crypto boom. One observer writes,

There was real optimism that killer consumer or industrial use cases would be discovered that leveraged the decentralized nature of crypto currencies and this would lead to new economic models and usher in a new era of peace and prosperity. I never got the crypto use case, but the thing that made me think I might be wrong was the passion of the people leading it to create something new and useful.

This doesn’t excuse any wrong doing by anyone in the industry, but I don’t think that most of the people that got into the industry intended for it to be as scam ridden as it has become. I think it turned out that the speculative nature of crypto projects has outweighed the usefulness of decentralization for end users, leading to Ponzi-esque business models.

Pointer from Tyler Cowen. A lot of smart people, probably including Tyler and certainly including his co-blogger Alex, thought that smart contracts using blockchain were going to change the world. Not everyone has given up on that, of course.

But let’s suppose that crypto is going to stay stuck in the nether regions of the underground economy. Then a lot of very talented entrepreneurs and software developers were handed VC money to try start-ups that were a waste of time. That is bad for the economy.

I would characterize the Dotcom era as a boom with a lot of mistakes, but the net result was a lot of value creation. I have high hopes that large language models, also known as artificial intelligence, will be similarly filled with errors but ultimately prove very productive.

But I don’t expect the crypto story to have a happy ending. The sooner those start-ups run out of money and discard their talented founders and developers, the better.

Another sector where I worry that the private market has drawn too many talented people is finance. But that is not easy to avoid. It will take a longer essay, but I would argue that the financial sector has become bloated because of regulation. My basic model is that regulators pass rules, and the sector responds with work-arounds. The net result is not better regulation, but an arms race in which more and more “rocket scientists” get drawn into Wall Street. I can spell out some examples in a longer post.

But industrial policy is uniquely positioned to misallocate talent. For one thing, while venture capitalists can be counted on to cut their losses as initiatives fail, government subsidies become entrenched. Consider the ethanol mandates, for example. By increasing corn production, these mandates probably cause a net increase in carbon emissions. But they are too popular in Congressional farm districts to ever be repealed.

“Building a road to nowhere” is an apt metaphor for industrial policy. Michael Strain writes,

Biden can subsidize semiconductor manufacturing with the stroke of a pen, but he cannot wave a magic wand to create workers who are qualified to staff chip-fabrication plants. Deloitte estimates that the US semiconductor industry will face a shortfall of 90,000 workers over the next few years. Just this month, Taiwan Semiconductor Manufacturing Company announced that it must delay production at an Arizona fab, owing to a lack of workers with the right experience and training.

…politicians cannot resist the temptation to use public funds to advance unrelated goals. For example, in February, the Biden administration required companies receiving federal subsidies for semiconductor manufacturing to ensure affordable childcare for their workers. But what if there are not enough workers immediately available to run daycares near chip plants? Such add-ons reduce the effectiveness of the subsidies

We have a transportation infrastructure that delivers energy to cars, primarily via gasoline. We may wish that we had a fleet of all-electric vehicles, with power sourced by wind and solar. But we do not have the infrastructure to deliver energy from where wind and solar power are abundant to where most of the cars are.

Also, I don’t believe that anyone has thought through the consequences of installing lots of solar panels that in a dozen years will be worn out and obsolete. In my opinion, we should be doing more research into materials science and less implementation of solar installations. Not zero implementation, but less.

For now, we are stimulating mining with harmful consequences. We are setting ourselves up for major environmental problems disposing of worn-out solar panels in fifteen or twenty years. And we are locking people into solar panels that are less efficient than what will be state of the art several years from now.

The demagogues who bash free trade are getting their way. Trade barriers and government subsidies will soon make “Made in America” synonymous with made inefficiently.

The big winners of the new industrial policy will not be working-class Americans. They will be lobbyists loitering in the halls of Congress, earning huge salaries playing the game of dialing for dollars to take from your pockets to give to favored businesses.