The United States has long held a belief in the power of free trade, but as experts Marc Fasteau and Ian Fletcher argue, this belief is not shared by other major economies around the world. In their new book, "Industrial Policy for the United States: Winning the Competition for Good Jobs and High Value Industries," Fasteau and Fletcher present a three-pronged approach—what they call their “three pillars of industrial policy”—involving strategic investments, protectionism, and a devaluation of the US dollar.
Given the significance of this book and the potential impact it could have on the markets and the global economy in the coming years should these policies be fully implemented, we recently engaged in an in-depth conversation with Marc Fasteau and Ian Fletcher on FS Insider. Our discussion focused on the key details of their book when it comes to free trade, the role of government in technology, the potential methods of devaluing the US dollar, and much more.
For podcast audio, see Great Power Competition and the Three Pillars of US Industrial Policy.
The Myth of Free Trade
Fasteau and Fletcher assert that the concept of free trade is a myth. "There is no such thing as free trade," says Fasteau. "The problem is that the US and the UK are the only two countries, maybe Australia, who really believe in it, and no other significant countries with significant economies believe in it." Instead, countries like China, Japan, and Korea use industrial policy as a core strategy to support and protect their economies.
Industrial policy, as defined by Fasteau and Fletcher, involves the government selectively intervening in the economy to support industries that are important. This includes not just high-tech industries but also any sizable industry that pays decent wages and generates a fair amount of income for the country.
"The first thing you need to know about free trade is that there is no such thing," Fletcher emphasizes. "And this has, in fact, been recognized even in the United States for centuries. But we forgot there's always a thumb on the scale when you're dealing with foreign countries. There are subsidies, there are hidden trade barriers…free trade is a chalkboard construct. And I don't care if it were the best thing. It just doesn't exist."
Not All Industries Are Created Equal
Fletcher explains that the first principle of industrial policy is that not all industries are created equal. "Some are better to have than others," he says. "They give you more profits, they give you more wages. They have better synergies with pulling up other industries in the rest of your economy. And that, of course, is leaving aside all the concerns of national security, public health, and environmental protection; some industries are better than others."
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Fasteau adds that the market won't do it on its own. "Free markets are great," he says. "We are not socialists. We believe that any policy that we're in favor of has to be designed in market conforming ways. But markets on their own are not enough to get you the best industries. You have to have your government deal with the fact that given that free trade is not going to happen, you have to have a rational tariff policy."
Both authors point to a long list of very successful technologies and industries that started with US government support, either exclusively within the US military or with major government funding. For example, the airline industry under President Herbert Hoover, the development of semiconductors, GPS, the internet, solar power, and many others. "All the work that we’re talking about…not just inventing it but helping in commercializing it" as well, Fasteau says.
The Three Pillars of Industrial Policy
Fasteau and Fletcher outline three pillars of industrial policy:
1. Strategic support for technology, innovation, and US industry: This involves not just inventing new technologies but also helping in their commercialization. Fasteau explains, "The government creates the platform on which the venture capitalists dance." This support is crucial until the private sector can take over and commercialize the product. "In the VC world, that's called crossing the valley of death to a viable commercial product. That's the government’s role. As soon as that's done and in the latter stages of it, the private sector has to be deeply involved in structuring the work that's being done and the prototypes, that’s when it goes to the private sector market. And that’s absolutely critical. I mean, that’s the engine from that point forward."
2. Protection against subsidized competition: To protect the investments made in new technologies, the US needs to implement tariffs and other protective measures against subsidized competition from countries like China. Fletcher provides the example of the Biden administration's 100% tariff on Chinese electric cars to protect the domestic electric car industry. "The second part is providing protection against subsidized competition, notably from China. But not just China, Japan and Korea heavily subsidize industries that they consider important," Fasteau explains.
3. Competitive currency: The US dollar is currently overvalued by about 16% against a trade-weighted basket of other currencies, they argue. Fasteau and Fletcher propose a market access charge, as outlined in a 2019 Senate bill, to reduce the foreign demand for American assets and lower the value of the dollar. This would make US exports more competitive and imports more expensive, helping to zero out the US trade deficit.
The Impact of Dollar Overvaluation
Fasteau explains that the overvaluation of the dollar is caused by two main factors: currency manipulation by US trade partners and a big net excess flow of capital by non-US private sector investors into the United States.
"The third pillar is having a competitive currency," Fasteau says. "Right now, the dollar is overvalued by about 16% against a trade weighted basket of other currencies, countries that we trade with. So why don't we have a dollar valued at a level today that balances trade?”
Fletcher proposes a market access charge to address this issue. "You impose a small tax on foreign purchases of American assets," he explains. "This was proposed in a bill in the Senate in 2019 by senators Baldwin and Hawley. That was a bill that we at Coalition for a Prosperous America helped to write, and it creates something called a market access charge, which is just a couple of percents tax when some Japanese bank or some Austrian pension funds wants to buy US treasury bills or shares of Microsoft or part of a shopping center in Orange County, California. And when you do that, you're going to reduce the foreign demand for American assets because there's a tax in the way. So it's no longer such a good deal, which means there's less demand for dollars, which means the price of the dollar, the exchange rate of the dollar with respect to other currencies goes down. Which means two things happen that we want to happen. Number one is foreign imports become more expensive in the US. So people are going to buy less consumer electronics from Japan and Korea. They're going to buy less consumer knickknacks from China. They're going to buy less luxury cars from Germany because they're going to be slightly more expensive. And American exports become more competitive. American beef is more competitive in Europe. American computer chips are more competitive in Japan. American aircraft are more competitive when we're competing for Air India's business. And because you're putting a thumb on both sides of the scale, that is by far the least traumatic, least complicated way to zero out the US trade deficit, which is horrendous. It's like six, seven, $800 billion a year, which is destroying jobs and deindustrializing our country and driving us deeper into debt to foreign nations."
Bipartisan Support
Fasteau and Fletcher emphasize that industrial policy is not a partisan issue. "The politics longer term of getting this right, I am actually pretty hopeful about, because…the usual divisions, Republican taking one point of view, Democrats taking an opposing one, don't really apply," Fasteau says. “There are people in both parties that support industrial policy. So that makes me hopeful, because for industrial policy to stick and to be institutionally solid, to eventually develop the specialized staffing in different parts of the government, that focus on this in a coordinated way, it has to be bipartisan. Otherwise it becomes a political football."
Fletcher agrees, pointing out that opposition to free trade is now the national consensus in both parties. "When I sat down to write my first book, which is called Free Trade Doesn't Work, in 2007, there were only about half a dozen intelligent people in the English speaking world I could even talk to about the subject," he says. "Free trade was such a dogma. Now, opposition to free trade is the national consensus in both parties."
The Challenge of China
When it comes to trade and economic power, the authors were emphatic that China and the US are clearly no longer friendly trade partners, and that China is more of a threat than the Soviet Union was during the Cold War era. "They are a great power competitor in the classic historic sense. That is to say, because they have the ability to assert power in rivalry with us for dominance of the global arena, they will. And they're actually more dangerous than the Soviet Union because the Soviet Union conveniently handicapped itself by agreeing to run their economy according to the scribblings of…Karl Marx. That was an incredibly stupid move on their part, because the communist economy does not work."
China, however, is much more pragmatic in its aims for technological or industrial supremacy. As Fletcher explained, "If doing things on a public sector basis will drive their economy and their technological or military capabilities forward, they’ll do it that way. If letting 1000 flowers bloom in the private sector and having a lot of private companies engaged in very loosely regulated capitalism will drive the economy forward and give them the wealth and the technology that they want, they'll do it that way too. Their very pragmatism makes them dangerous."
"They're more pragmatic, I think, than the US. The other thing is that the US has a horrendous level of Beijing influence in Washington. But it mostly does not come from lobbyists explicitly hired by the Chinese government and registered under the Foreign Agents Registration Act as explicitly lobbying for their interests on Capitol Hill. It does not come from the personnel of the Chinese embassy in Washington lobbying for Chinese interests or even handing out satchels of $100 bills to bad people who sell out this country. It has mainly come from the US multinational corporate sector that is making money manufacturing in China and selling to China, doing Beijing's bidding on Capitol Hill and in the White House and in the regulatory agencies without leaving Beijing's fingerprints on it. And you can see how insidious that is. You can see how much blame Americans bear for serving foreign interests because it was profitable."
Fasteau echoes these concerns, highlighting the far-reaching impact of China’s influence. "There are lots of examples of that," he says. "China gets angry. They say, well, no, we'll kick you out. That will motivate the people on Wall Street to lobby against whatever it is that China doesn't want the US to do. It can be as direct as that. So, as Ian says, this is more than just a purely economic rivalry. It really does matter who has the most advanced weapons, who has the best AI. The Institute for Technology and Innovation Foundation (ITIF) has just come up with a good report on the high technologies where China is ahead of the US and others in which it appears poised to become ahead of the US. So this is really an all-fronts fight that is critical in the long run and we have to get this right, and it's not going to be easy."
The Role of Deregulation
Fasteau and Fletcher also address the need for deregulation to speed up the development of critical industries. Fasteau acknowledges the necessity of balancing environmental concerns with the need for expedited infrastructure projects. "The worst example…is trying to modernize the electric grid. It's too difficult, and it's too difficult to build big bridges and it's too difficult to build mines. Now, we don't really want to go back to the wild west where you could do anything you want and then just leave a big mess and leave, and not worry about the health risks you're creating and so on. So there's a balance that has to be struck and it's a trade-off. And we clearly do too much of that. On the other hand, to remain competitive without making a wasteland out of our country, we need tariffs to protect not only against direct subsidization of imports, but also against lower environmental standards, which reduce the costs of our competitors as compared to what it costs to produce the same product in the United States because we regulate emissions more closely."
Conclusion
In conclusion, Fasteau and Fletcher argue that the US needs a robust industrial policy to compete in the global economy, particularly against China. This policy, they argue, should include support for new technologies, protection against subsidized competition, and a concerted effort in lowering the value of the dollar. Historical examples demonstrate the success of such policies, and the challenge posed by China underscores the urgency of implementing them. The bipartisan nature of having a strong industrial policy (as seen increasingly under both Trump and Biden administrations) and the desire to lower the value of the US dollar have clear implications for markets, the economy, and the potential macro landscape for investors.
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