Healing American Industry

With each passing week, the call for an "industrial policy" grows louder. Every Democratic presidential hopeful has some version of this idea, and Walter Mondale was reportedly ecstatic at the recent publication of Harvard professor Robert B. Reich's The Next American Frontier, which argues for such a policy. Business Week and Wall Street potentate Felix Rohatyn have been beating the drum for an industrial policy for several years.

Most conservatives and libertarians reflexively denounce such proposals for further government intervention, asserting that all we need is the free market. But this response, while technically correct, is simply not adequate.

In fact, we have an industrial policy today, though it is more implicit than explicit. The net effect of the US tax system, regulatory system, and even the public school system amounts to a policy toward business and industry. And, unfortunately, as free-marketeers have been pointing out for years, that policy is very damaging to economic growth.

The damage has been growing more obvious for years, but the recent recession managed to bring it into sharp focus. What were once "basic" US industries—autos, steel, machine tools—have failed to adjust to a changing world economy and are now being undersold by lower-cost, higher-tech firms overseas. This has led to wrenching unemployment and severely depressed regions. The only way such firms can survive is by drastic restructuring—yet in most cases, their remaining work forces refuse to accept competitive (lower) wage scales or to give up obsolete work rules. Moreover, interest rates remain so high that the billions needed for modernization are simply not being invested.

So it's quite clear that there is a problem, one of massive proportions. What should be done about it? Unfortunately, what is being offered as an industrial policy fails to address the causes of the problem and would only make matters worse. Whether it's the United Auto Workers, congressional Democrats, or the Business Week/Wall Street crowd, their basic proposal includes some sort of business-labor-government planning body and a development bank to provide grants, loans, and loan guarantees at taxpayer expense.

It should be crystal-clear by now why such a scheme will not work. First, there is no reason whatever to expect the individuals running either body to be able to obtain better information or make better decisions than the current participants in the capital markets—who, after all, have their own money at risk. Moreover, it is naive to expect such bodies to operate from some sort of godlike perspective outside the normal political process. As Sen. William Proxmire (D–Wisc.) recently put it:

Money will go where the political power is.…It will go where the union power is mobilized. It will go where the campaign contributors want it to go. It will go where the mayors and governors as well as congressmen and senators have the power to push it. Anyone who thinks government funds will be allocated to firms according to merit has not lived or served in Washington very long.

The most likely result of this sort of industrial policy is the preservation of obsolete firms, technologies, and processes ("lemon socialism") plus the funding of a few politically sexy high-tech boondoggles like the Concorde supersonic jet and the Synthetic Fuels Corporation.

What we need, instead, is a thorough overhaul of the government's existing anti-industrial, anti-entrepreneurial policy. Such a policy should be based on Joseph Schumpeter's insight that true capitalism is a process—not an end state—a process he called "creative destruction," whereby inefficient, outdated firms and technologies are continually displaced by new and more productive ones.

What might such a policy consist of? Its first element would be a tax policy that rewards enterprise rather than discouraging it. For starters, as both conservative Ronald Reagan and neoliberal Lester Thurow have urged, abolish the corporate income tax and the entire patchwork of inefficient credits, loopholes, deductions, exemptions, and paperwork that go with it. Corporations don't really pay the tax, anyway—consumers do. Second, abolish all taxation of savings and investment, including both the capital gains tax and taxation of dividends and interest. The final element in ensuring a strong flow of new business investment would be to abolish antitrust restraints—especially those on joint R&D efforts—as urged by both Thurow and many free-market economists. Together, these changes would put US entrepreneurs on at least an equal footing with the Japanese.

But to restore competitive flexibility—the ability of both companies and their work forces to adapt to change—a heavy burden of regulation must be lifted, too. Labor laws that put the government's hand on the union's side of the scale must be abolished. Without their more-than-equal bargaining position, it is doubtful that US auto and steel workers would have been able to force their wages up to more than twice that of their Japanese competitors or to resist the kind of flexible work rules that enable Japanese cars to be produced with half the number of labor hours of US cars. Likewise, all restrictions on imports must be removed. The constant spur of world competition is essential to the process of "creative destruction" that will bring us all the benefits of innovation and growth.

Finally, if we are to move into the high-tech, flexible, decentralized economy in which our future competitive advantage lies, it's essential that we have a work force of competent, literate, adaptable people. To get them, we need to break the monopoly of the bumbling public school system, introducing real competition into the educational marketplace. Only then will schools be held truly accountable for results by those who pay the bills.

Advocates of liberty must do more than simply arm-wave about free markets. Today's anti-industrial policy is the cause of our stagnation. A big-government industrial policy would only make matters worse. But a policy that fosters entrepreneurship and competition—that sort of "industrial policy" is worth fighting for.