Clyde Prestowitz: What U.S. Industrial Policy Gets Wrong

Last Updated May 26, 2010 5:23 PM EDT

The growing U.S. trade deficit and the decline of American
manufacturing have both been explained away as "fair bargains":
We get inexpensive goods from abroad, and in turn shift our economy from
commodity manufacturing to intellectual innovation. But according to Clyde
Prestowitz, author of The Betrayal of American Prosperity, this has
actually been a terrible deal.

Prestowitz spoke with Eric Schurenberg about unfair competition,
protectionism, and the difference between smart and dumb industrial policy.

The standard explanation is that fair trade and open trade has been a good
deal for Americans. You disagree. Why?

Well, I think that we often don’t have fair
trade or open trade, and in fact, I think it’s a misnomer to talk
about trade. What we have is globalization. Trade is: I produce something, ship
it to you, you produce something ship it to me. What we have now is global
corporations — I put my factory in your country, you put your factory
in my country. We have massive cross-border flows of capital and technology. Trade
theory assumes that those cross border technology and capital flows don’t
take place. But they obviously do take place. So when we talk free trade, it
really doesn’t describe the situation that we have globally, and
because of that, when we talk about the benefits we’re not really
thinking about the totality of the situation.

Now a lot of people talk about the iPhone as an example of how this works:
We design some cutting-edge technology, it changes everything, and that’s
a high-profit/high-margin operation. Then if the actual manufacturing takes
place in another place, then it’s a low profit margin and America
prospers. But you have a different take?

Well, let’s take the manufacturing step of that.
It may be that that manufacturing cannot be competitive in the United States, but
it may be that it could be competitive in the United States. So if the
manufacturing is taking place elsewhere, because there has been some subsidy,
to induce investment ...

A subsidy by a foreign government?

... Because a foreign government has offered a U.S.
manufacturer 50-year tax holiday. If the manufacturing is moving because of the
tax holiday, that’s not good for the United States. That means that
we’ve lost jobs and lost skills and lost production in an area where
we really are competitive.

Now on the other hand, if that manufacturing is moving
because the other location really is more competitive in that particular
step, then that may be a benefit to us. But then you also have to consider
something else.

As you said, we’ve had this notion for a long
time that we’ll do the design and the high-tech development and we’ll
let that dirty, low-tech manufacturing go. But what we’ve seen, in the
case of laptop computers for example, is that for a long time, we (i.e., Dell) did
the design in the U.S. and Taiwan did the assembly. Taiwan is now doing the

So you see a gradual movement. In fact, Applied Materials,
the world’s leading producer of equipment to make semiconductor
devices and photovoltaic cells, has just moved a big piece of the firm to China.
So you have a connection here.

The global supply chain presumes that the linkage between
manufacturing and design and development and marketing is so forth are discrete,
distinct links that can easily be broken up. But in fact, they are tightly
adherent and one moves and there’s a tendency then to drag the rest
of them with it.

Some people might say that protectionism rises every time there is an
economic downturn and that it’s understandable but can be disastrous.
They point to the Smoot-Hawley tariff of the 1930s — that’s
how bad things can go if you get too carried away at limiting trade.

That’s actually a good point, and there are two

First, there is an absolute conviction that the
Smoot-Hawley tariff caused the Great Depression and caused World War II. Full
stop; nobody questions it. In fact, some of the most sophisticated economic
analysis, by people like Barry Eichengreen at the University of California,
have demonstrated that the Smoot-Hawley tariff did not cause the Great Depression,
didn’t have a big effect on the Great Depression — and certainly
not on World War II.

But having said that: I think that it’s wrong
for us, when we discuss this topic of where production takes place and how the
global supply chain should be constructed, to immediately think that if we’re
concerned about the flow of that production and technology, that’s
protectionist. I think because we’re not in trade, we’re in
globalization, other countries are thinking very hard and strategizing at a
very sophisticated level about how to grab pieces of that supply chain for
their own economy. And to do that, they use a lot of techniques. The government
may intervene in currency markets in order to undervalue their currency; many Asian
countries are doing that right now. The government may, as I said earlier,
offer tax holidays or free infrastructure or investment capital grants in order
to induce a move of production.

Every state does that?

Every state does not do that. But, there is a huge
difference in between, let’s say what the state of Alabama can do and
what a nation can do. Remember the state of Alabama does not control federal taxation;
it does not control depreciation schedules. The amount of chips that it has to
play with is very limited compared to what a nation can do — and many
of them are quite good at it. So you have non-market forces at work in the
global economy, whether you like it or not. The question is do you just take
the laissez-faire approach and not respond, or do you have some kind of

Let’s talk about what that response ought to be. You’ve
talked about a number of things in your book. One of them is raising the
savings and investment rate in the country to 20 percent — that would
be a complete reversal of the trend over the past generation at least. How
would you accomplish that, and why is it necessary?

Well, it’s necessary because the United States
is a low-saving, low-investment economy and because of that, we have
accumulated chronic trade deficits and chronic federal budget deficits. So we’re
highly in debt, domestically and internationally, and the debt levels have now
reached the point at which, domestically, our ability to borrow is beginning to
be a little bit of a question mark. And internationally, our freedom of action
is being constrained because we hesitate to do certain things or talk in
certain ways about the guys who are bankers. So we’re losing our
freedom of action, our independence, as well as our ability to, for example, do
stimulus programs if we have a recession.

When you say the guys who are bankers — you mean China?

Not just China. We borrow a lot of money from Japan, Singapore,
Hong Kong, Saudi Arabia, and Russia. We’re a non-discriminatory

So I think that it’s both economically and geopolitically
important that we reverse this low-saving, low-investment situation. How do you
do that? We did it in 1941 — in September 1941, when I was born, the U.S.
savings rate was about 10 percent. In September 1942, a year later, it was 40
percent. So if you’re really serious, you can do it.

Of course that was war time. But let’s take
mortgages. We have a tax write-off for the interest you have on a mortgage. We
have that for your first house, we have it for your second house, and if your
account is good, you get it for your third house. In fact, if you take a home
equity loan and use the proceeds to take a cruise with your wife, you get to
write that interest off too. We subsidize that consumption — and we
have to stop, or at least constrain it. Maybe I’ll give you the
interest rate on your first house, but you know, not on your home equity loan,
not on your cruise.

You also talked about something called smart globalization. That sounds
like an umbrella term for industrial and economic policy in the U.S. —
is that what you mean?

Well, I think that there are two ways to think about
industrial policy. One way is the classic way that industrial policy gets
discussed: the notion of picking winners and losers. The government will pick a
champion company. This was the French/European model, particularly in the
immediate post-World War II era — the Brits, the French, and the
Germans had flag-carrying companies that the government supported. And when
Americans talk about industrial policy, that’s typically what they
have in mind.

Now the Japanese and the Koreans have a bit of a different
approach to that. They don’t necessarily pick a particular company,
but they determine that they want to be competitive in the steel industry or in
the aviation industry or in the semiconductor industry. They will then devise
policies that on the one hand encourage investment in those industries, that on
the other hand promote research and development in those industries, and that may
be used to attract investment from abroad. They may say to a foreign company: If
you want to be in our market, fine, but you have to produce here, you have to
bring technology here. And they don’t necessarily back a particular
company; they’d back a developmental area and with the objective of
becoming a leader.

Then there is a third way to think about it ... Let’s
take something like photovoltaic cells — solar panels. Right now,
China and Germany and Japan are putting a lot of effort into developing
leadership in photovoltaic cell technology and commercialization. Now, if the
United States has no policy — that’s a policy, that’s
a decision; the United States is making a decision that we’re not
going to be in photovoltaic cells.

So in a way, you can’t avoid having some kind of
industrial policies. So the question is not, ‘Will you or won’t
you [have a policy]?’ — it’s ‘Will
[your policy] be smart or dumb?’