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The Week of February 27, 2023: CHIPS’s billions, industrial policy, the economy, the budget and much, much more.
T hose who believe in free markets — or who are familiar with the history of developed economies after they became developed (or, maybe, completed postwar reconstruction) — ought to have little time for industrial policy. Free markets are bottom-up, flexible, and work with their own imperfections. They function through a continuous process of communication that recognizes that the valuable message sent by a price yesterday may be worthless today. Much of their operation is by trial and error. To be sure, there are disasters — plenty of them — but they often point to a better use of capital elsewhere or next time. The prosperity free markets have brought, and the human flourishing they have enabled, is unmatched.
By contrast — and despite some successes — industrial policy has a generally inglorious track record. That’s unsurprising given the practical, political and intellectual territory it shares with central planning, that most predictable of all the pathways to economic folly. Top-down, rigid, and highly bureaucratic, central planning, in all its various forms, rests on the fantasy that those doing the planning have the information they need to steer the economy in some predetermined “right” direction. Hayek had a few things to say about that.
Much the same is true of industrial policy, which, to put it very roughly, is when those running the government decide to take a more assertive approach toward shaping the economy. Typically, they use the resources of the state to favor certain preferred sectors or companies, employing a wide range of methods including regulation, protection, tax treatment, loans, outright infusions of cash, and even nationalization.
Industrial policy in that classic sense — often characterized as picking winners and losers — has, with some notable exceptions, been out of favor in most Western economies for quite a while now. The prevailing orthodoxy has been that the success or failure of a company or sector is better left to the operations of markets than to the machinations of politicians and bureaucrats, who are unaware of any number of unknowns and all too open to cronyism. The prevailing orthodoxy has been correct. But sadly, given the way that thinking is evolving not only on the left, but also in parts of the right, that inconvenient truth may not be enough to save it.
That’s a tragedy to be discussed at another time. What’s worth noting for now is that even “market fundamentalists” (or most of them) will acknowledge that different assumptions may apply when national security is involved. This is an issue currently coming into sharp focus as the government embarks on a program that will involve spending billions of taxpayer dollars to encourage the rebuilding of America’s semiconductor manufacturing capacity.
Chips matter. The disruption in semiconductor supply chains that followed the pandemic was a painful reminder both of the ubiquity of semiconductors in the economy and of the importance of maintaining a secure supply chain that can guarantee access to them. What we learned was that our semiconductor supply chain is not so secure as we thought. And the closer that the people who were paying attention looked, the more worried they became.
The U.S. has retained its leadership in chip design, and other key areas at the high end of the semiconductor sector, but only about twelve percent of the world’s semiconductor manufacturing capacity is located here (down from nearly 40 percent, 30 years ago). By contrast, about 75 percent is concentrated in East Asia, with Taiwan, in particular, having a market share of a little over 50 percent of the global “foundry” market (outsourced chip manufacturing).
Not only that, as the Wall Street Journal’s Yuka Hayashi explained last month:
[T]he U.S. doesn’t mass-produce the most advanced chips, defined as those smaller than 5 nanometers. Taiwan, an island at the center of political tensions with China, accounts for 85% of that market, while South Korea represents the remaining 15%, according to the Center for Security and Emerging Technology at Georgetown University.
The military buys 90 percent of its advanced chips from Taiwan. Indeed, some of those chips are only manufactured there.
In a probably hopeless attempt to inoculate myself against charges of heresy, I’ll now cite Adam Smith before going any further. In The Wealth of Nations, Smith recognized the need to support a “particular sort of industry . . . necessary for the defence of the country.” It’s not much of a stretch to see how chip manufacturing capacity might be such a “particular sort of industry.” Going beyond the minimum number of chips needed to satisfy our military needs, much of the economy would soon be in deep trouble without a regular supply of semiconductors, and that would certainly undermine our ability to defend ourselves.
Rebuilding America’s chip manufacturing capacity to ensure that we are never in that position will be hugely expensive. So it goes: “Defence”, wrote Smith, “is of much more importance than opulence.” And however much the Biden administration might like to claim otherwise, it will, like most forays into industrial policy, almost certainly be economically inefficient. However, treat this spending as an insurance policy and a different set of calculations apply. What once looked feckless could instead be seen as an example of prudence.
Smith understood how supply chains and national security were intertwined: “If any particular manufacture was necessary . . . for the defence of the society, it might not always be prudent to depend upon our neighbours for the supply”.
Indeed, it might not, especially when those “neighbours” are thousands of miles away, hostile (China), or vulnerable to China. Smith also recognized that if the domestic market was unable to support the manufacture of those “necessary” goods then “it might not be unreasonable that all the other branches of industry should be taxed in order to support it.”
The migration of chip manufacturing away from the U.S. has been, in part, a reflection of markets doing what they do (and, in the case of China, mercantilism doing what it does). For example, it costs over 40 percent more in the U.S. than in Taiwan to build and operate a semiconductor fabrication plant (“fab”). Differentials like that matter, but they should have started to matter less once China’s economic and political model began taking its current turn. By how much less is a tricky question, but it’s hard not to think that semiconductor buyers have slow to reprice China risk (a widespread failing in Western economies).
However, once pandemic-related disruptions highlighted the vulnerability of America’s semiconductor supply chain, markets began to respond. Proposals for the construction of new fabs in the U.S. were up sharply in 2020. Given the continuing deterioration in the international situation, something of an American chipmaking renaissance might well have occurred even without government intervention. How far and fast it would have gone is anyone’s guess. But guessing is a risk too far in an era in which old assumptions about China and globalization, never that sensible in the first place, are as dangerous as they are delusional.
And so last year saw the passing of the CHIPS and Science Act. To oversimplify, this was (in part) a response to the increasingly powerful technological challenge posed by China, a challenge I discussed in a Capital Letter in late 2021. My conclusion then was that, in deciding what to do, useful precedents could be drawn from measures taken in the U.S. after the Soviets took an early lead in space (“the Sputnik moment”) and from the public–private sector cooperation that worked so well with Operation Warp Speed.
In principle, those parts of the Act designed to encourage research and innovation in areas such as AI and quantum computing might fit the bill, so long as they are not overwhelmed by the extra baggage that tends to burden government programs in the Biden era, something that will be worth examining on another occasion. The other key part of the Act is designed to encourage the expansion of chip manufacturing in the U.S. To look at this somewhat theoretically, this is to be achieved by spending billions of dollars in subsidies to plug the gap between what the market will pay and what national security demands, at least for a while.
The WSJ’s Hayashi:
The public investment is significant: roughly $39 billion in manufacturing incentives for chip plants known as fabs, as well as material and equipment factories, plus $13.2 billion for research and development and workforce training.
There is a separate tax-incentive program, which provides a 25% advanced investment tax credit for manufacturing and processing equipment.
Needless to say, such incentives come with strings attached. Given the Act’s objectives, for example, it makes sense that the bill prohibits (with some exceptions) recipients of taxpayer money from expanding their semiconductor operations in China.
On the other hand, there’s this (from a White House fact sheet, August 9, 2022):
The bill requires recipients to demonstrate significant worker and community investments, including opportunities for small businesses and disadvantaged communities, ensuring semiconductor incentives support equitable economic growth and development.
It will also support good-paying, union construction jobs by requiring Davis-Bacon prevailing wage rates for facilities built with CHIPS funding.
And there’s this (from the CHIPS for America Fact Sheet, February 28, 2023):
Applicants must commit to developing and maintaining a highly skilled, diverse workforce, including by outlining their plans to hire economically disadvantaged individuals. In addition, applicants are encouraged to work with government organizations, educational institutions, labor unions, industry associations, and other strategic partners to meet the needs of the semiconductor industry in their region. Finally, any applicant requesting more than $150 million in funding must provide a plan for access to affordable, accessible, reliable, and high-quality child care for both facility and construction workers….
[T]he CHIPS Program Office will evaluate projects based on applicants’ plans to commit to future investment in the U.S. semiconductor industry, including to build R&D facilities in the United States; support CHIPS research and development programs; create opportunities for minority-owned, veteran-owned, and women-owned businesses; demonstrate climate and environmental responsibility; invest in their communities by addressing barriers to economic inclusion; and commit to using iron, steel, and construction materials produced in the United States.
In short, recipients of CHIPS money will not be allowed to use the funds to pay dividends or to fund share buybacks. In principle, this might be reasonable enough (the devil will be in the details, of course), but another provision reflects the Biden administration’s broader dislike of buybacks.
The rules go further than just prohibiting companies from using the funds for dividends or buybacks. The government will “require all applicants to detail their intentions with respect to stock buybacks over five years.” They’ll have to show whether they intend to limit or cease the practice, and the review process will include looking at how much companies have relied on stock repurchases in the past.
Oh yes, there’s also this (via the Tax Foundation):
Among firms that receive more than $150 million in funding, Commerce will require “Upside Sharing” of a portion of “excess profits” with the U.S. government. The notice defines excess profits as any cash flows or returns that exceed what firms submit for their projected cash flows as part of their application. The so-called “upside sharing” does not specify what portion of “excess profits” the government would take, but it would not exceed 75 percent of a recipient’s direct funding award. One way to think about it is if a project is surprisingly successful, the government can claw back up to 75 percent of the awarded funds.
This micromanagement approach is bad for competition—and bad for innovation.
Writing in the Wall Street Journal, Greg Ip argues that “industrial policy is most likely to succeed when the goal is narrowly defined and leverages private-sector incentives. It is less likely to succeed when it is used to solve multiple social goals disconnected from the industry’s economic viability.”
Steve Rattner, the former head of Obama’s auto task force, tweeted:
Affordable childcare is an admirable goal – but it has nothing to do with semiconductors. If we want the CHIPS act to work, it can’t be used as a pack mule for unrelated policy priorities.
From presiding over the fiasco in Kabul to formulating its climate policy, this administration has repeatedly shown a dismaying degree of geopolitical myopia. If it took this country’s semiconductor vulnerability as seriously as it should, it would not support using the CHIPS program as a device for pursuing an unrelated social and political agenda in ways that not only ensure waste, but risk discouraging the participation of companies that could otherwise have a valuable role to play.
It would also be confronting the regulatory tangle described by Adam White, writing for the Wall Street Journal here:
[The CHIPS Act’s] billions of dollars in federal subsidies will be squandered if lawmakers don’t do something about the host of regulations that currently block or deter the construction of chip fabrication plants and the broader ecosystem of facilities and companies a domestic semiconductor industry requires for long-term success.
This was made painfully clear by an October 2021 report from Georgetown’s Center for Security and Emerging Technology, which showed that the construction of new chip fabrication plants is governed by myriad intersecting federal and state environmental regulatory frameworks, whose uncertain timelines and requirements present major roadblocks. The center reiterated in June 2022 that regulatory modernization is a “first step” toward semiconductor competitiveness: “Efforts should include finding and eliminating redundancies between state and federal permitting regulations for high-tech facilities by streamlining environmental, health, and safety regulations.”
I’m not holding my breath.
Meanwhile, America’s vulnerability in semiconductor manufacturing does not end with the lack of fabs (and people to staff them). There are certain raw materials to worry about too.
The Wall Street Journal (January 14, 2023):
The lasers that imprint tiny circuit blueprints on silicon wafers use purified neon gas, made from raw neon typically harvested from large air-separation units attached to steel plants. Those facilities produce the neon when they separate oxygen from the air for use in steel furnaces.
Since the steel industry largely moved out of the U.S. over the past half-century, there is currently very little neon gas being produced domestically. Most has come from Ukraine, Russia and China, but Russia’s invasion of Ukraine has left China as the world’s main source.
“Is this a risk for the U.S.? Absolutely,” said Matthew Adams, an executive vice president at Electronic Fluorocarbons LLC, a Massachusetts-based company that imports, purifies and sells neon and other gases. “A prolonged ban of neon exports from China to the U.S. would shut down a significant portion of semiconductor production after inventories are exhausted.”
A handful of other raw materials used in chip making, such as tungsten, which is transformed into tungsten hexafluoride and used to build parts of transistors on chips, are similarly sourced primarily from China. To truly untie the U.S. chip industry from China would entail undoing several decades of globalization, something industry leaders say isn’t practical.
There is, theoretically, no shortage of neon. It comes from the air. It can be distilled anywhere, but it’s not cheap to do so. As for Tungsten, there are significant deposits in the U.S. The question is whether it will be possible to mine it. Very little tungsten has been mined here for decades, and it is easy to see a clash coming on this topic between the administration’s environmentalist wing and those who actually care about national security. It’s hard to be optimistic that the latter will prevail.
As for “industry leaders” worried that undoing several decades of deglobalization is impractical, they will have to find a way. Globalization in its evolved form was the product of a world where the U.S. was unchallenged at the top of the heap, and Beijing was playing a deceptively docile long game. Those days, for now, are gone, and “industry leaders” will need to adjust to today’s reality rather than cling to the hope that the old order will reassert itself. Because it won’t.
National Review Institute: Ideas Summit
We will be holding an ideas summit in Washington DC on March 30-31.
Topic: The Sources of American Strength
Participants include:
Ryan T. Anderson, David L. Bahnsen, Louis Brown, Senator Tom Cotton, Allen C. Guelzo, Pano Kanelos, Megyn Kelly, Terry & Matt Kibbe, Bjørn Lomborg, Jessica Melugin, Douglas Murray, Vivek Ramaswamy, Ian Rowe, Carrie Severino, Elise Westhoff, Rich Lowry & National Review Writers
More details here.
The Capital Record
We released the latest of our series of podcasts, the Capital Record. Follow the link to see how to subscribe (it’s free!). The Capital Record, which appears weekly, is designed to make use of another medium to deliver Capital Matters’ defense of free markets. Financier and NRI trustee David L. Bahnsen hosts discussions on economics and finance in this National Review Capital Matters podcast, sponsored by the National Review Institute. Episodes feature interviews with the nation’s top business leaders, entrepreneurs, investment professionals, and financial commentators.
In the 106th episode, David is joined once again by Renè Aninao, a macroeconomic and foreign-policy analyst at Corbu, a leading Wall Street research firm. The conversation is not for the faint of heart, but they talk a bit about 30 years of post-Cold War market reality and the current reality in Ukraine. When all is said and done, you will have a better understanding of how financial markets intersect with geopolitics, the opportunity staring President Xi in the face, and the unlikely beneficiary of it all. Furthermore, it will be clear how all of this is an economic story — a lesson Jerome Powell has understood for over a year now.
No Free Lunch
David has also launched a new six-part digital video series, No Free Lunch, here on National Review Online. In it, we bring the debate over free markets back to “first things” — emphatically arguing that only by beginning our study of economics with the human person can we obtain a properly ordered vision for a market economy…
The series began with a discussion with Fr. Robert Sirico of the Acton Institute. Later guests include Larry Kudlow, Dennis Prager, Dr. Hunter Baker, Ryan Anderson, Pastor Doug Wilson and Senator Ted Cruz.
Yes, the six-part series now has seven parts.
Enjoy.
The Capital Matters week that was . . .
Crypto
Tomas Philipson & Jeffrey Wernick:
The SEC’s attempts to regulate crypto, including the recent actions taken against Kraken and Paxos, and last week’s proposed regulations that would handicap the regular banking operations of crypto firms, are in full swing this month. But the recent partial recovery of crypto markets post-FTX tells us that the main problem was bad actors, not crypto as such…
The Pandemic
Slowly but surely, new cracks are appearing in the wall of silence denying Chinese culpability in causing the nearly 7 million deaths attributed to Covid. In a classified intelligence report on the origin of the SARS-CoV-2 virus that caused the Covid-19 pandemic, the U.S. Department of Energy concluded, based on new but still secret intelligence, that the Covid-19 virus leaked from a lab in Wuhan, China. The DOE — which runs biosecurity labs at the Lawrence Livermore National Laboratory, a biological-safety program, and the Biological and Environmental Research (BER) program to fund research into organisms’ genetic codes and how to “reengineer” them — now agrees with the 2021 assessment by the Federal Bureau of Investigation that the pandemic was likely the result of a lab leak . . .
Healthcare
Robert Popovian & Catherine Windels:
For decades, lobbyists for the pharmacy-benefit-management (PBM) industry have been telling policy-makers, employers, and patients that PBMs (middlemen responsible for the administration of the prescription-drug benefit for various health-plan payers) save everyone money. They argue that opaque negotiation, rebate contracting, and vertical and horizontal integration are intended to help lower biopharmaceutical spending. Unfortunately, the promises of savings are a mirage, with no data-driven analysis to back them up. The PBM industry is thus staunchly opposed to laws that provide transparency into their business practices…
In New Mexico, the LFC Medicaid study’s authors used “secret shoppers” to attempt to make appointments with primary-care physicians throughout the state. Shockingly, only 15 percent of them were able to make an appointment with a primary-care doctor.
This is just one of many data points that echo the point made by Obamacare critics over a decade ago, who said early and often that health care is not the same thing as “coverage.” But policy-makers did not heed those warnings, and since Medicaid was expanded, the number of recipients in New Mexico has exploded while the number of providers has declined rather dramatically. The LFC report, for example, revealed that 47 percent of New Mexico’s population is on Medicaid, which places the state at the very top of the list in terms of the percentage of its population receiving benefits...
Industrial Policy
I could bore you once again with all the reasons why industrial policy/central planning doesn’t usually work as planned. But instead, I will just point you to these articles.
The first one reports that instead of trying to address the cost of child care by lifting the many idiotic rules (some federal and many state and local) that constrain supply and jack up the price, the Biden administration is going to tell companies that if they want to be able to get some of the $39 billion in semiconductor subsidies, they will have to provide “high quality” child care…
Climate
Germany’s government is a somewhat unlikely coalition between the center-left Social Democrats (a party that has, traditionally at least, drawn support from the industrial working class), the Greens, and the economically liberal (by European standards) Free Democrats.
And when it comes to the Autobahn, the coalition is divided…
That’s one thing never to forget. The shift to electric vehicles (EVs) is happening as a result of a series of political decisions, not consumer demand. But if there’s one thing that the sad history of central planning ought to have taught us by now, it is that switches on this scale tend to succeed when they are bottom-up, the product of a continuing exchange of “information” between manufacturer, innovator, and consumer. To dictate them from the top is, for the most part, asking for trouble…
The Consumer Product Safety Commission is still thinking about your gas stove.
The independent federal agency will be issuing a request for information in the Federal Register “seeking public input on chronic hazards associated with gas stoves and proposed solutions to these hazards.” The CPSC is interested in knowing about chemical hazards from gas-stove use. It wants feedback from consumers, manufacturers, other government agencies, researchers, and nonprofits…
As I reread that story and straightened my tinfoil hat, dark thoughts entered my mind. What if a facility not too dissimilar to Apple’s (perhaps — even darker thoughts crowd in — without an override) came as a standard in EVs or their chargers? And what then, if an electricity grid of which the reliability had been eroded by decarbonization (thanks to underinvestment in conventionally generated power, overinvestment in renewables, or both) came under pressure? And what . . .
Then I brought this line of thought to a halt. It was clearly nonsense…
Residents in agricultural areas have good reason to feel put upon. Their industries are often targeted by regulators and disdained by the metropolitan cognoscenti. They may not be hiding in the caves of Yan’an, but farming communities from the Netherlands to North America are rebelling against extreme government regulations, such as banning or restricting critical fertilizers or the enforced culling of herds. Meat and dairy producers are assaulted in a hysterical article in the New York Times that predicts imminent “mass extinction” caused by humans and suggests that to keep the planet from “frying” we will need to reduce meat and dairy consumption in short order…
The Budget
Medicare’s trustees say its Hospital Insurance Trust Fund will run out even sooner than that. When this happens, if Congress hasn’t come up with serious reforms, Social Security benefits will be cut by roughly one quarter, according to its trustees. The alternative is to raise the payroll tax by more than 30 percent. A more likely scenario is that that politicians will transfer money to pay Social Security benefits from general funds, doing away with its longstanding structure as a benefit workers earn with their payroll-tax contributions, eliminating any connection between workers’ employment earnings and their benefits, and running it as just another welfare program competing for funding from the government’s general fund. If you believe that touching benefits isn’t popular, try ending a program Americans would prefer to retain by replacing it with a welfare program lacking Social Security’s financial controls or earned-benefit requirements. The same scenario is true for Medicare, except the numbers are scarier…
Transportation
Yesterday, Chuck Schumer joined the chorus of Democrats blaming the Trump administration for the Ohio train accident. He said, “The Trump administration repealed requirements for an electronic braking system because, according to them, the safety benefits were not worth the cost . . . I think the people of East Palestine now know that analysis was wrong and that they’re suffering the consequences of rail companies putting profits over people.”
He’s repeating a line that Pete Buttigieg and White House officials have been spouting for weeks. It’s not true, and they know it’s not true…
As I wrote last week, not one part of Buttigieg’s policy response would have prevented the accident in East Palestine. Parts of it, including the crew-size mandate, are sops to organized labor. Other parts, including the maximum fines, have nothing to do with the Ohio accident at all. Perhaps these senators would like a different secretary of transportation, but Buttigieg is the guy right now, and he’s the one who will be exercising the new powers this bill gives him.
Inflation
John Cochrane is the Rose-Marie and Jack Anderson Senior Fellow in Economics at the Hoover Institution and the author of a new book, The Fiscal Theory of the Price Level. In this wide-ranging conversation, Cochrane discusses the root causes of inflation, what we can (and can’t) do about it, the economists who influenced his thinking, and how his father inspired him to become an academic.
Rent Control
For decades, lawmakers in New York State have been chipping away at the rights of property owners, specifically New York City landlords. In an ill-conceived attempt to make housing more affordable, lawmakers have imposed regulations that actually worsen the problem for renters and punish the people they rent from…
The Corporation
Who owns Apple, and who hired Tim Cook as CEO? Vanguard is the company’s largest institutional “holder,” but that is not an owner. The investors on whose behalf Vanguard holds shares may be owners, but they often don’t know it and they certainly don’t act like it. Say Vanguard holds shares for a teacher pension fund. Is that fund an owner, or are the teachers, or are the taxpayers, who must meet their commitments to teachers regardless of the fund’s value?
Trade Unions
The Washington Post story about the nomination of Julie Su as secretary of labor begins, “President Biden on Tuesday nominated Julie Su to be the next labor secretary, elevating a longtime advocate for workers to implement a key part of the administration’s agenda.” The print version of the same story carried this headline: “Biden nominates longtime pro-worker advocate to lead Labor Department.”
Which workers?
Probably not truck drivers, who had their business models upended by California’s A.B. 5 law, of which Su was “an architect,” according to the Post, during her tenure as California’s labor secretary from 2019 to 2021…
The Economy
Last week, we learned that the blip down in inflation at the end of last year was just that, a blip.
One of the oldest economic rules of thumb is that inflation begins to seriously decline when the short-term interest rate is above the inflation rate. By that measure, the Fed has been woefully slow to tighten, which made the apparent slowdown in inflation last year a puzzle.
Tax
The problems with the U.S. tax system are well known, but is any country doing better? The small Baltic state of Estonia is regularly ranked No. 1 in the developed world for its tax system, which is both conducive to economic growth and simple to enforce. A report from the Tax Foundation lays out how the U.S. could adopt some of its ideas…
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