Time can make a huge difference. This is certainly true of the US’ stance on industrial policy. Just a few years ago, “industrial policy” was a derogatory term that Washington reserved almost exclusively for China as if it had forgotten that it was a pioneer of the practice.

In the 1980s, the Reagan administration set annual ceilings for Japan’s car exports to the US, and forced Tokyo to accept rules that limited Japanese chip exports while extracting improved US access to the Japanese market.

With the US emerging victorious from the Cold War, Washington saw a reduced need for industrial policy. Meanwhile, it frowned on the countries that adopted the practice, blasting China’s industrial policy as “non-market”.

Some 30 years on, industrial policy is back in fashion in the US. While continuing to censure China, Washington passed the Inflation Reduction Act and the Chips and Science Act in 2022.

Industrial policy is commonly defined as measures taken by a government to shape the economy by targeting specific industries, firms or economic activities through tax incentives, subsidies, protective regulations and research and development support.

China was a latecomer on the scene. Taking its cue from the East Asian countries that transformed their economies through industrial policy, Beijing put in place something of its own in 1986.

China’s industrial policy is similar to that of Japan, South Korea and the European Union, albeit more pervasive. For this reason, it has withstood challenges the US brought before the World Trade Organization.

In contrast, US industrial policy is one of a kind. What sets it apart from the pack is, first and foremost, its purpose. Conventional industrial policy is internally focused, aimed at developing national capacity. However, US industrial policy has, as well as investing in American workers and science, an important additional goal: suppressing competitors, especially those perceived to be narrowing the gap with the US.

The Reagan administration’s “managed trade”, since outlawed, was intended to clamp down on Japanese automobile and semiconductor industries. The exercise was hugely successful, and contributed in no small part to Japan’s three lost decades.

Washington’s industrial policy for semiconductors today is designed to cripple Chinese competition or to ensure the US maintains, as National Security Adviser Jake Sullivan put it, “as large of a lead as possible”.

US industry policy distinguishes itself in another important aspect: approach. The Biden administration says its industrial policy is rooted in national security concerns, and maintains that there is no room for compromise on such matters.

It is easy to see why Washington links its industrial policy with national security: to justify the measures it wishes to take. Consequently, US industrial policy includes extreme measures outside the realm of conventional industrial policy.

The US’ “high fence” around its semiconductor sector, for example, includes export bans, investment curbs and blacklists of competing companies.

On top of an arsenal already swollen with trade, the Swift global payments system and the dollar, Washington is now using industry policy as a weapon to achieve its geopolitical objectives – not unlike an unscrupulous sportsman tripping up a competitor to win a race.

While conventional industrial policy operates behind the border, America’s industrial policy extends its reach beyond US territory, adversely affecting foreign governments and companies. Foreign companies deemed to have violated US sanctions are subject to heavy fines, while foreign nationals on the wrong side of US rules face prison terms.

In an aberration from conventional industrial policy, the US calls for allies and like-minded economies to align against its competitors. The Biden administration has formed a “ Chip 4” alliance with South Korea, Japan and Taiwan, and seeks to set up a “critical minerals buyers club” with the European Union and the Group of 7.

It pressured Japan and the Netherlands into enforcing semiconductor export curbs against China, while prohibiting funding recipients under the Chips and Science Act from expanding capacity there. Moreover, the US is pushing “friend-shoring” to isolate China.

In addition, US industrial policy is likely to have contravened global trade rules. China has filed a suit with the WTO over the US’ chip export bans. Some in the EU have threatened WTO action against the US over an Inflation Reduction Act subsidy scheme that excludes electric vehicles made outside North America.

To allay similar Japanese concerns about the implementation of the Inflation Reduction Act, the Biden administration concluded an agreement with Tokyo on critical minerals for electric vehicle batteries, which was presented as a sort of free-trade agreement. But such narrow sectors “do not count as a free trade area”, according to Inu Manak, a trade policy expert at the Council on Foreign Relations.

Washington’s industrial policy has serious consequences for the world. It is creating new trade barriers. Market distortion at its worst, it threatens to dismantle the current global supply chains, which would lead to substantial inefficiency and loss of economic output.

Some of the effects of US industrial policy are already evident in the semiconductor sector, where it is no longer possible to freely source or sell raw materials, products, manufacturing machines or technology. As Taiwan Semiconductor Manufacturing Company (TSMC) founder Morris Chang put it, “in the chip sector, globalisation is dead”.

President Joe Biden has stressed on numerous occasions the necessity of US global leadership. However, on industrial policy at least, the world would be much better off without it.

Source : SCMP

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The rise of security-driven economic policy in industrial countries gives licence to atavistic inward-looking policy thinking, infecting the framing of development strategies at a critical time in countries on the cusp of major developmental breakthroughs like India and Indonesia.

Geopolitics is changing the global economic policy landscape. Today’s backdrop of strategic competition and conflict has seen the return of industrial policy in advanced countries, driven by a security-based logic mixed with a second-best approach to the energy transition without a price on carbon. There has been an explosion of trade interventions, industrial policies and subsidies, exacerbating the threat to the world economy posed by the widespread derogation from the global trade rules.

How should developing economies like India and Indonesia navigate this policy environment, where self-sufficiency and import-substituting strategies are finding potent new favour?

East Asian economies have effected the only significant transformation from economic backwardness to advanced economy status in modern times. It’s thus wise to understand the lessons from the East Asian growth miracle, which still hold true today. And developing economies, constrained by their fiscal capacity, should recall the waste and futility of past industrial policies that picked industry champions rather than creating public goods to lay the base for broad-based industrial growth.

Successful East Asian development, based on the historical experience of Japan, South Korea, Taiwan, Singapore, Southeast Asia and China, was founded on trade-oriented growth (anchored in the disciplines of participation in international markets) and deeper integration into the international economy, not retreat from it or reliance on import-substitution. The rapid trade growth enjoyed by these economies was supply-driven, built on the expansion of market share in old, established industries, not expansion of trade in new, high-growth sectors of the global economy. Government investments were directed towards social and economic infrastructure in public goods such as roads and schools, with withdrawal from state involvement in enterprise.

Today, policymakers seem to live in a different age. Domestic events and geopolitical circumstances are visiting the prospect of stagnating growth upon established industrial economies, globalisation appears to have peaked, the international economy is becoming fragmented, and a policy pathology that favours self-sufficiency and import-substituting industrial policy is sweeping around the world.

The trope that a less optimistic outlook for global market growth now recommends that emerging economies turn to inward-looking import-substitution does not square with the experience of successful industrial growth in Asia.

In an international economic context, development is about drawing abundant labour into more and more productive employment, lifting productivity and national incomes.

Pro-development strategies are thus those that favour export-specialisation in labour-intensive products, drawing large amounts of labour into internationally competitive production and higher productivity employment. With the accumulation of capital, dynamic comparative advantage drives a more technology intensive export trade structure over time. The beneficent corollary of export-oriented development strategies has been a distribution of income that commonly favours labour.

The recent trend towards self-reliance and security has seen countries emphasise the production of high-tech capital-intensive goods from the start. Focusing on these sectors requires skilled labour, in short supply relative to abundant unskilled labour, and expensive government outlays, which come at the cost of providing essential government infrastructure. Failing to create jobs risks an entrenchment of inequality and an unsustainable stretching of public resources if a country grows old before it gets rich.

Successful trade-oriented growth comes from absorbing labour into industries that can capitalise on its abundance and establish international competitiveness. Doing this allows countries to take over others’ market shares as comparative advantages evolve, a process underwritten by a policy regime based on the principles of non-discrimination and open markets.

Even in a period of slow growth, the logic of comparative advantage still holds. Import-substituting policies undermine this transition by restricting access to low-cost and high-quality capital and technological inputs, preventing firms from achieving international competitiveness.

The East Asian economic miracle was certainly a messier and more complex story than has sometimes been portrayed in the narrative that describes its main features. In Japan, Northeast Asia, Singapore, China and Southeast Asia, the policy strategies that drove success were fashioned in different institutional and political settings and each had their own distinctive national character. Policy idiosyncrasies, technological context, geographic size and location have all shaped particular national paths and patterns of development across the region.

But some factors were ubiquitous throughout the East Asian experience. Opening up to competition from foreign markets and embracing international investment were central to rapid growth by enabling access to inputs that facilitated the absorption of abundant domestic labour into productive manufacturing employment. In addition to domestic reforms to support openness, increased mobilisation of state investment in education, health, transportation, communications networks and supportive industrial infrastructure, and reduced state shares in economic enterprise and the allocation of capital, typified successful industrial policy across the region.

China was no exception to these principles or to this experience. It has been a central element of it, at scale.

India and Indonesia, two of Asia’s most promising candidates for transformative industrialisation over the coming few decades, stand at a critical juncture in their development trajectories. Their youthful populations and recent strong economic performance put them in a demographic sweet spot.

Yet both countries are in danger of being caught in the undertow of industrial policy 2.0. The attunement of their development strategies to the principles derived from the East Asian experience would position them better both to fulfil their economic potential and avoid the danger that both now face of jobless growth.

Source : East Asia Forum

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Achieving net zero carbon emissions will require an estimated seven-fold increase in demand for transition-critical minerals between 2021 and 2040. Currently, the United States and the European Union import 80 per cent and 98 per cent of their critical mineral needs respectively, while Japan imports 90 per cent. Given these dependencies, there are heightened concerns around access to supply of transition-critical minerals, especially given the concentration of supplies in China.

While the extraction of critical minerals is dominated by Chile and Peru for copper, Indonesia, the Philippines and Australia for nickel, the Democratic Republic of the Congo for cobalt and Australia for lithium, China is the leading processor. To reduce dependency on these concentrated supplies of transition-critical minerals, developed countries have introduced industrial policies such as reshoring the sourcing of transition-critical minerals and the production of low-carbon technologies.

In the United States, the Inflation Reduction Act provides subsidies of US$7500 for electric vehicle (EV) purchases as long as the components, such as batteries, are produced in the United States or in allied countries that have a free trade agreement (FTA) with the United States. This has led to Japan signing a limited FTA with the United States on minerals so it can provide components that qualify for the subsidy. The European Union, Indonesia and the Philippines have also approached the United States for similar limited trade agreements.

The European Union has proposed legislation — the Critical Raw Materials Act — which requires members to reduce their dependence on China for critical minerals from 80 per cent to 65 per cent, with a target to increase supply from within the European Union to 10 per cent. Since 2020, Japan has also introduced a range of industrial policies to incentivise the relocation of Japanese-owned facilities from China to ASEAN and other countries. In May 2022, Japan introduced the Economic Security Promotion Act which aims to secure supply chains for critical minerals and support the development of critical and emerging technologies.

Industrial policy targeted at onshoring or building supply chains with allies is unlikely to reshape the industrial geography of critical minerals any time soon. The investments required to uproot supply chains face uncertainty from increased demand, shifting industrial policy and geopolitics, and long lead times, as well as limits from relying only on supply from ‘allies’. Even if onshore extraction could be increased in developed countries, pushback on environmental concerns is likely to hamper progress. Meanwhile, industrial policy has the potential to disrupt or raise the cost of access to critical minerals and transition technologies, especially for developing countries.

The better policy response is not onshoring or creating strategic alliances. Expanding and diversifying investment in resource-rich developing countries would increase and diversify supply, reducing reliance on a few countries and firms. China must be accommodated in the interim given its significant role in reducing the cost of decarbonisation in other countries.

Diversifying investments to resource-rich developing countries also has its challenges, as industrial policy intended to increase the value-add of mineral resources can distort investment decisions. Fiscal constraints mean that subsidies are not an option, so policies have come in the form of restricting raw materials exports, linking mining concessions with phased-in downstreaming and local content requirements.

Indonesia, for instance, passed a law in 2009 restricting exports of unprocessed minerals and requiring mining concessions to build smelters by a given deadline.

In the case of nickel, Indonesia has the largest reserves in the world and accounts for 22 per cent of exports. In 2014 Indonesia banned the export of nickel ore. The policy has been deemed a success, with exports of ferronickel and stainless steel increasing from US$2.2 billion in 2014 to US$29 billion in 2022. This led to increased investment from China and nickel mining companies such as Vale, spurring economic growth in east Indonesia. With ample supplies of nickel, copper and graphite, Indonesia has ambitions to become a supply hub for EVs and batteries.

The costs and benefits of export restrictions as a means of increasing value-add are, however, problematic. Value-add is not just the increase in exports of the final product, or even jobs growth — which is low given the capital-intensive nature of the industry — but the difference between the cost of production and cost of materials, including the cost of building infrastructure and meeting energy needs and revenues forgone as other suppliers expand market share for unprocessed ore.

Success in expanding nickel production might not be repeated with other commodities where Indonesia is not a major producer or where substitutes are readily available. And other minerals may not attract investments in the way that nickel did. To ensure that further downstreaming leads to value-added industrial development, complementary policies such as building infrastructure, access to clean energy and human capital development will be necessary.

As the search for lithium to make EV batteries shows, it is not enough to be rich in one resource. Keeping trade open and predictable is as vital to resource-rich countries as it is to resource-poor economies. It is also essential for the diversification of refining and processing capacity to reduce dependence single suppliers.

Source: East Asia Forum

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