America is rewriting the economic playbook

PITTSFIELD — Over the past year, Congress agreed to plunk down more than $2 trillion to remake the nation.

Three different bills targeting infrastructure, semiconductor chips, and the greening of America are meant to transform the U.S. and regain its position as the premier competitor worldwide.

The new Congress, which gives the GOP a slim majority in the House, has already raised the prospect of spending cuts in exchange for their agreement to raise the country’s debt limit. If the Republicans get their way, the $280 billion Chips and Science Act, the $400 billion Inflation Reduction Act, and the $1.2 trillion infrastructure bill may become a bargaining chip in the discussions over future spending.

The fact that much of this spending will occur over the next decade makes whittling down the total package an easier target than cuts to programs such as Social Security or Medicare. However, there are plenty of land mines for those on both sides of the aisle doing so.

The passage of these bills was a humongous effort. Months of discussions hammered out a careful balancing act between conflicting desires from both parties and their constituencies. Climate change, for example, a subject near and dear to much of liberal America, was painstakingly pared with hawkish views on the economic threat of China. Help for the rural areas of the country was married to the need to preserve and protect the environment. Support for Ukraine, the need to promote energy production, and further subsidies for electric vehicles were the result of complicated horse trading and two years of negotiations.

The point is that these three huge budget busters are addressing long-delayed measures to transform major holes in the domestic economy. Fixing crumbling infrastructure, development of clean energy, coupled with preserving and expanding the existing fossil fuel industry, and protecting our manufacturing sector, especially in the semiconductor and auto industry, are in some respects, vital initiatives that are just too big to fail.

Aside from the size of these programs, how these spending initiatives will be implemented is already calling into question an entire era of trade policy in the U.S. Traditionally, America adhered to a post-war practice of promoting global trade through domestic spending programs. As a nation, we embraced the concept of comparative advantage. It is an economic theory that implies that each national economy should produce what it does best and most efficiently. Countries should therefore confine their efforts to those products. This would lead to gains in efficiency, international trade, and specialization. As such, the U.S. has long been an advocate of market liberalization, tariff elimination, and free trade in our economic policies. But times are changing.

These policies through the years have cost the country a great deal in terms of the economy, and society in general. Some credit should go to Former President Donald Trump, who spent four years articulating the idea of “America First.” He argued correctly that our policies have caused a decline in manufacturing communities. Others point to the deindustrialization of our economy, as we deliberately shipped jobs and industries to foreign countries in the name of comparative advantage. The concentration of wealth and rising income inequality in this country are symptoms of these trends.

The COVID pandemic also revealed another cost of our traditional trade policies. Cost savings like just-in-time inventories and dependency on foreign supply chains for a myriad of goods came back to bite us where we sit. The sudden scarcity of all kinds of products and parts, coupled with spiking inflation, has shown us the folly of our ways.

“In today’s world,” wrote U.S Treasury Secretary Janet Yellen in a December 2022 essay for Project Syndicate, “I believe that any economic agenda must consider the potential for regional and global shocks to impact our supply chains, including those shocks driven by the policies of certain foreign governments. We are concerned about vulnerabilities that result from over-concentration, geopolitical and security risks, and violations of human rights.”

In short, the reliability of trade is now just as important as comparative advantage, if not more so.

Part and parcel of the remaking of America is a long list of rules and regulations spelling out where and what can be made and by whom. Each project is expected to single out U.S. domestic manufacturers for preferential treatment, whether they are the most efficient producers or not. The U.S. electric vehicle tax incentive program, for example, insists that local assembly and local content requirements are met to qualify for a tax credit of up to $7,500.

Batteries must be made in North America. Green products such as wind turbines, rare earth mining, as well as semiconductors must be sourced whenever possible from domestic companies. High-tech imports and exports will be increasingly governed by the dictates of national security.

As one can imagine, these policy changes will have an immense impact on our trading partners. For decades foreign nations have benefited greatly from our free trade approach. This change to the status quo has immediately caused a negative response from across the globe. Japan and South Korea are unhappy with the Chips Act. The European Union disagrees with the whole idea of subsidies and tax credits for our key target industries.

Acknowledging their grievances, the Biden Administration has come up with an approach called “friend-sharing.”

The White House contemplates a large array of new bilateral and multilateral agreements with friendly nations in both emerging markets and developing countries, as well as advanced economies.

Using existing organizations such as the U.S-EU Trade and Technology Council, and the Americas Partnership for Economic Prosperity, among other existing trade pacts, the U.S. is hoping to create “secure” supply chains in target areas such as the solar, semiconductor, and rare-earth sectors for starters. By the way, “secure” is polit-speaking for ex-China, Russia, Iran, etc.

Friend-sharing is going to be gradual and targeted to countries where certain sectors and products are considered critical to our national and economic security.

Australia is just such a case in point.

The U.S. is working to reduce China’s dominant market share in the production of magnets and rare-earth minerals. Both are critical inputs for clean-energy capacity, military technologies, and consumer electronics. Australia produces both, and we are working with them to build rare-earth mining and processing facilities located in both countries.

However, no matter how friendly we try to be, the facts are that the game has changed and most of our trading partners are not going to like that. As a result, expect to see tit-for-tat increases in foreign tariffs, subsidies, and credits in answer to the “America First’”tone of these U.S. mega-trillion-dollar initiatives.

Global organizations such as the World Trade Organization and the International Monetary Fund will decry this trend, arguing that the U.S. is moving away from globalization towards regionalization. That, they say, will only further declines in world economic growth and living standards over time. Private industry will argue that targeted subsidies for products like semiconductors will only cause worldwide overproduction.

All of the above is likely to be true when we confine our arguments to the pristine theory of economic comparative advantage. But this country is only now waking up to the geopolitical and social costs of blindly adhering to this principle for decades. Relying on others to supply and deliver vital goods and services to our nation only works in a friendly world where everyone agrees all the time. “Reliability of trade,” on the other hand, has become a concept we can no longer afford to ignore.