Can industrial policy boost long-term growth? Recent policies implemented by U.S. President Joe Biden and his administration have revived a very old American argument about the extent to which the U.S. economy might gain or lose from trade and industrial policy. While some argue that these policies consist mainly of coddling inefficient industries, others note that they have a long history of boosting industrial activity and productivity growth.
But under current circumstances, to argue whether or not the United States should subject its economy to trade and industrial policy mostly misses the point. Like it or not, the U.S. economy is already subject to aggressive trade and industrial policies, and has been for decades, only these policies have been designed at least as much abroad as they have been in the United States.
That is because in a hyperglobalized world, every country is affected by policies and conditions initiated abroad. When one country boosts its manufacturing sector relative to domestic demand, for example, as long as that country can freely export its excess production, its trading partners must reduce their manufacturing sectors relative to their own domestic demand. Supply and demand must balance globally, and that is the only way this can happen.
Savings and investment must also balance globally, to take another example, in such a way that when one economy implements policies that create a domestic imbalance between the two, this forces the rest of the world to adjust by running the opposite imbalance. To be more specific, if export-enhancing policies in one country force domestic savings to exceed domestic investment, as long as that country has unfettered access to foreign financial and capital markets, the country into which it directs its excess savings must either increase its investment or, if it cannot do so (as is the case in most advanced and many developing economies), it must accept structural changes that reduce domestic savings. The imbalance between savings and investment in the latter country, in other words, is determined by the imbalance created in the former.
This is especially true of the United States because of the special role the U.S. economy plays as absorber of last resort of global excess savings or, to say the same thing in another way, as global consumer of last resort. This role emerges from the fact that the United States takes on by far the dominant role globally in accommodating global trade and capital distortions. It does so mainly because, since the 1970s and early 1980s, the United States has chosen for geopolitical and ideological reasons to eliminate most restrictions on its capital account, letting foreign investors have unfettered access to open U.S. financial markets.
This decision has had three important consequences for the U.S. economy. First, because of its deep and sophisticated financial markets and its transparent and high-quality governance, roughly half of all the excess savings in the world find their way into the U.S. economy. Although this has less to do with the needs of the United States than with the needs of foreign investors, the U.S. economy must nonetheless adjust to these massive net inflows, by allowing foreign purchases to drive up the value of the U.S. dollar, among other ways. Because investment in the United States is constrained by weak demand rather than by scarce capital, this leaves the U.S. economy no option but to adjust in the form of lower domestic savings.1
Second, a country’s capital account is the obverse of its trade account, so the fact that the United States absorbs roughly half of all the excess savings in the world also means that the United States absorbs roughly half of all global trade surpluses, which it does by running the world’s largest persistent trade deficits. This is why describing the U.S. role as “absorber of last resort” of excess global savings is just another way of describing the U.S. role as “global consumer of last resort.” The two mean the same thing.
And third, because U.S. trade and savings imbalances are partly, or even mostly, driven by industrial policies implemented abroad, this means that U.S. unemployment, debt levels, interest rates, the competitiveness of the U.S. manufacturing sector, and many other aspects of the U.S. economy are also affected by these policies implemented abroad. The idea that the United States controls these and other major aspects of its economy, in other words, is just a fantasy. In a hyperglobalized world, no country can control its domestic economy unless it controls its trade and capital accounts.
How Are Policies in One Country Matched by Policies in Another Country?
The consequences can be seen most dramatically in the sharp, multi-decade decline in the U.S. share of global manufacturing. The United States never made a conscious decision, as a form of domestic industrial policy, to drive down the role of manufacturing in its economy. This decline was largely the consequence of industrial policies abroad designed to drive up the role of manufacturing in the countries that implemented them.
The data showing this are quite explicit. While manufacturing comprises 15 percent of global GDP, according to the most recent World Bank data, it comprises a much lower share of GDP for advanced economies that run persistent trade deficits and a much higher share for those that run persistent surpluses. Among the former countries, for example, manufacturing is 11 percent of U.S. GDP, 10 percent of French GDP, 9 percent of Canadian GDP, and 9 percent of the United Kingdom’s (UK) GDP. Among the latter, it is 18 percent of Singaporean GDP, 19 percent of German GDP, 21 percent of South Korean GDP, and 34 percent of Taiwanese GDP (and 26 percent of mainland Chinese GDP).
This lopsided distribution of manufacturing across surplus and deficit economies isn’t a coincidence, nor is it the result of decisions made in the United States. It is mostly the result of trade and industrial policies in several major economies that were designed to improve manufacturing competitiveness in these economies by effectively forcing households in those economies to subsidize their manufacturing sectors. These policies have resulted not just in trade surpluses, as domestic demand inevitably has failed to keep up with production, but also in the increasing role of manufacturing in their economies. Over time, global manufacturers have migrated to these surplus economies because that is where direct and indirect manufacturing subsidies were greatest.2
But these policies also have affected these surplus countries’ trade partners, especially economies with open and attractive financial markets, like the United States and the UK. As manufacturing has migrated to the surplus countries, by definition it must have migrated from somewhere else, and the data show that it has migrated mainly from countries that ran the corresponding deficits.
This shouldn’t come as a surprise. Because supply and demand must balance at the global level, policies in one country that force transfers from household consumers to subsidize manufacturers are automatically matched among trading partners by transfers from manufacturers that subsidize consumption. In the latter case, these transfers aren’t the desired result of explicit industrial polices. They are simply the automatic result of the requirement that trade at the global level must always balance.
Consider, for example, the decision by a country to undervalue its currency. An undervalued currency works through the economy by effectively transferring income from domestic households, who are net importers, to subsidize producers of tradable goods. It is these transfers that explain why countries with undervalued currencies tend to run trade surpluses: not only are their industries globally more competitive, but their households retain too low a share of total income to allow them to consume in line with production, so these transfers also ensure that such economies cannot import in line with their exports.3
But because the effect of trade and industrial policies in such surplus-running countries is to undervalue their currencies against the U.S. dollar (they typically depreciate their currencies by buying U.S. dollars), the consequence of their undervalued currencies is an overvalued dollar. This represents the opposite transfer, in which producers of tradable goods in the United States are forced effectively to subsidize American consumption. The consequence is that a policy designed to force household consumers to subsidize production in one country has the effect of forcing producers to subsidize household consumption in the United States. Put another way, a form of so-called U.S. “industrial policy,” no matter how little desired such a policy is in the United States, had to emerge as the obverse of other countries’ industrial policy.4
The point is that trade and industrial policies implemented in surplus-running countries have just as much of an impact on the manufacturing sectors of deficit-running countries as they have on the manufacturing sectors of the surplus-running countries, only that the impact on the former is the obverse of the impact on the latter. That is why if one group of large economies aggressively implements trade and industrial policies that affect domestic manufacturing competitiveness, domestic employment, or the relationship between domestic savings and investment, its trade partners are also affected by the same policies—albeit in the opposite direction—to the extent that they do not implement policies to control the impact of the surplus-running countries’ policies on the deficit-running countries’ own trade and capital accounts. Policy intervention in one set of economies becomes policy intervention in other economies through the channel of trade and capital flows.
How This Matters for U.S. Policy
This has important implications for the ways in which U.S. policies affect the U.S. economy. There are basically three ways the United States can respond to its special position as global consumer of last resort. First, Washington could decide to do nothing, implementing neither trade nor industrial policies to counter the policies implemented abroad. Confused economists refer to this as the “free market” or “free trade” option, but of course the refusal to impose countervailing measures doesn’t mean that the U.S. economy is absolved from government intervention in the economy. It will continue to be affected by industrial policy anyway, but these policies will be designed abroad—in Beijing, Berlin, Tokyo, Seoul, Moscow, and other centers whose policies cause their economies to run persistent trade surpluses. In this case, American “industrial policy” is effectively the obverse of whatever policies its more aggressively mercantilist trade partners choose for themselves.
Second, the United States could respond if Washington chooses to implement its own countervailing industrial policies in order to protect and expand strategically important sectors of the economy. In that case, while the United States could encourage and protect specific manufacturing sectors, its continued trade deficits—a required condition as long as the United States persists in absorbing the excess savings of its trade partners—mean that the overall U.S. manufacturing sector will prolong its long-term decline. Strategically important sectors of the economy may do well, in other words, but only at the expense of the rest of U.S. manufacturing.
Third, Washington could choose to opt out of its accommodating role in absorbing global trade and capital imbalances. This would allow it to protect American manufacturing in general, but not necessarily in strategically important sectors in which other countries have already obtained a comparative advantage—like China’s prowess with electric vehicles, solar panels, and batteries. The most likely way the United States might opt out of its outsized role in absorbing global imbalances would be by imposing across-the-board tariffs on U.S. imports or—more effectively—by restraining the unfettered access foreigners have to U.S. financial markets, which it could do by imposing taxes on financial inflows. As these tariffs or financial taxes were gradually raised until the U.S. trade and capital accounts were in balance, the United States would increasingly escape its role of balancing trade and industrial policies implemented abroad.
Whatever it decides, in a hyperglobalized system of trade and capital flows, in which many major economies choose to implement policies designed to alter their trading and manufacturing advantages, the United States cannot simply choose to disassociate its economy from industrial policy. One way or another, as long as its trade and capital accounts are determined by global trade and capital imbalances, the U.S. economy will be subject to the distortions created by government-ordained trade and industrial policies.
The real U.S. choice is to determine whether those policies are designed in the United States or designed abroad. Either the United States will decide which industrial sectors are strategically important to its future, or its major trading partners will do so, leaving the U.S. economy to specialize in whatever the rest of the world chooses not to.
Aside from this blog, I write a monthly newsletter that focuses especially on global imbalances and the Chinese economy. Those who would like a subscription to the newsletter should write to me at chinfinpettis@yahoo.com, stating affiliation. My Twitter handle is @michaelxpettis.
Notes
1If net foreign inflows do not result in an increase in U.S. investment, the balance of payments dynamics require that they result in a reduction in U.S. savings. The latter occurs in the form of higher unemployment, higher household debt, higher fiscal deficits, or some combination of the three. I explain why this must be the case in Trade Wars Are Class Wars (co-authored with Matthew Klein, Yale University Press, 2021) and in a previous blog post. See Michael Pettis, “The U.S. Trade Deficit Isn’t Caused by Low American Savings” Carnegie Endowment, August 8, 2018.
2I discussed the role of manufacturing and trade imbalances in a recent Phenomenal World essay. See Michael Pettis, “Trade and the Manufacturing Share,” Phenomenal World, June 28, 2024.
3Confused economists often ascribe these surpluses to a generalized comparative advantage, but comparative advantage can only be realized in the exchange of goods, and not in their production. A world of trade governed by comparative advantage is inconsistent, in other words, with persistent trade imbalances.
4It should be noted that if the U.S government decided to drive up the value of the U.S. dollar, this would be considered a kind of industrial policy. When foreigners do this, however, it is considered simply market behavior, even though this behavior is the result of government policies implemented abroad that force their consumers to subsidize their producers in ways that drive up domestic savings rates.
