How to Rescue a Drowning Economy

America does not need economic planning if planning means the centralized, detailed, input-output planning associated with the Soviet Union. America does need planning, however, if planning means the strategic coordination of planning associated with a corporate finance committee in a large corporation. Corporate finance committees do not plan the detailed activities of the various divisions in a large firm, but they exercise strategic judgments on where the firm should expand when they allocate investment funds. Some kinds of activities are pushed as the “growth areas” of the future; others are milked as cash cows with none of their earnings plowed back into future expansion.

At the national level such decisions are called industrial policies. If the Reaganauts fail to make America economically competitive again, as now seems highly likely, the debate about whether the United States ought or ought not to have industrial policies is apt to be the key economic debate of the 1980s. Minding America’s Business is an excellent introduction to explaining why the United States needs industrial policies and what other countries are doing in their industrial policies.

Everyone should know by now that the United States is becoming poor relative to the rest of the industrial world and is losing one industrial competition after another; but the details of this decline are superbly documented by Magaziner and Reich. In per capita GNP the United States is now tied for tenth place among industrial countries, after Switzerland, Denmark, Sweden, Germany, Iceland, Norway, Belgium, Luxembourg, and the Netherlands. The French are tied with us and the Japanese rapidly pulling up behind us. German workers have twice as many paid holidays and vacations as American workers. American males can expect to live four years less than those of Switzerland, the world leader, while American females lag “only” three years behind. America ranks eighteenth in infant mortality. Air pollution in the US exceeds that in other industrial countries. The homicide rate is eight to nine times that of other major industrial countries. The authors give a blow-by-blow description of how American industry was knocked out of international competition in the production of steel, the manufacture of TV sets, and the manufacture of electrical generators. Wherever they look, they find something that a country that likes to call itself “number one” can be ashamed of.

The common explanations for foreign success and American failure are that our competitors are catching up and that we have too much government. It is easier to catch up economically than it is to break new paths, or so the argument goes. If so, it is now the United States that has the “easy” task of catching up. We, not they, are the ones who are behind. Since the United States is the only industrial country in the world that has had no growth in productivity over the past four years, we seem to be failing at even the “easy” tasks.

Too much government is the Reagan administration’s answer, but this argument runs into problems. However you measure government intervention, our foreign competitors have more of it than we do. Try firing a worker in Europe and see what happens. America is the easiest place in the world to fire workers. If the American businessman frets because he has to cope with intrusive government bureaucrats, he should try living under the “administrative guidance” of the Ministry of Industry and Trade (MITI) and the Bank of Japan. Minding America’s Business rightly dismisses the “too much government” explanation and instead finds that the problem with American business is American business: the time horizons for investment and development are too short; we are badly deficient in process engineering, quality control, and in programs that would encourage exports.

In any case, the “too much government” hypothesis is not one that will have to be disproved theoretically. The Reaganauts will prove whether this hypothesis is true or false during the next three years. If current policies restore economic growth, Reaganomics will have been proven right and debates about industrial policies will die out. If current policies do not restore economic growth, then it will be obviously true that salvation does not lie in the direction of “getting the government off the backs of the people.” Debates about less government will die out and be replaced with debates not about more government but about what the government should do to promote economic growth.

The strongest argument for industrial policies is not that they are needed, although they are, not that they can be made to work, although they can, and not that other countries used them to beat us, although they did; but that the United States is now developing a horribly inefficient set of industrial policies based on congressional investment banking. With the loans to Chrysler and Lockheed, Congress decided upon a strategy of keeping declining and ultimately doomed “sunset” industries open—while real industrial policies would speed up the closure of the sunset firms. With the Alaskan trans-Canada natural gas pipeline bill, Congress decided to assume all of the risks of a project few would describe as one that supports the sunrise industries of either today or tomorrow. In carrying out really effective industrial policies, government never takes 100 percent of the risk.

“Trigger pricing” in the steel industry keeps open old, obsolete facilities by holding the price of steel above what it can be produced for in new, modern facilities. Inefficient steel managers earn high profits as a result and plow them into acquiring energy companies such as Marathon Oil. Real industrial policies make sure that inefficient managers do not have the funds to contaminate the rest of industry with their incompetence.

By deciding to eliminate the corporate income tax through the back door with accelerated depreciation allowances rather than having the courage to eliminate that tax through the front door, Congress decided to subsidize old, inefficient, capital-intensive industries such as steel rather than new, efficient, labor-intensive firms such as semiconductors and computers.

Under the provisions of the corporate tax law adopted last July, firms are allowed to buy and sell depreciation allowances—technically called “leasebacks.” It was this provision, in combination with the accelerated depreciation, that led to the de facto elimination of the corporate income tax, as far as the federal government is concerned.

If an efficient firm is making taxable profits, it can buy unused depreciation allowances from inefficient firms and use them to eliminate federal tax payments. In 1981, for example, IBM reduced its federal tax by buying unused Ford depreciation allowances. Since one dollar in tax credits can be purchased for 80 to 85 cents, the purchasing firms get a net tax reduction but they still essentially pay taxes. Instead of going to the federal government, however, the money goes to the inefficient firms that sold their unused depreciation allowances. The net result is a corporate tax system that collects little revenue but reallocates substantial amounts of money from efficient to inefficient firms—hardly what a rational industrial policy would call for.

America now has an industrial policy. It just happens to be an industrial policy to school ourselves in the economic foot. The de facto industrial policy of supporting sunset industries comes about for a simple political reason. Those in the sunset industries demand that something be done. They are voters, often influential ones, and will be listened to.

There are only two possible responses. A country can have an industrial policy of protecting its sunset industries and watch its national economic sun set as it prolongs the agony of decline. Or a country can have a policy of promoting sunrise industries so that there are new and better job opportunities for the workers of sunset industries. Whatever the rhetoric, no government “does nothing.” The Reagan administration could have vetoed the guarantees for the Alaskan trans-Canada natural gas pipeline, but it did not.

Since industrial policies are going to exist it is important to design institutions that work. No government investment bank could be worse than Congress when it comes to investment banking. No set of overtly designed industrial policies could give as much support to sunset industries as the present covert industrial policies do. The time has come to recognize what we are doing and start doing it right.

Other successful economies are marked by aggressive investment banking—usually backed by the government. For all practical purposes, the US does not have investment banks. Some institutions, such as Morgan Stanley, are called investment banks, but none of them has major amounts of money that can be committed to long-run investments. They are instead middlemen or brokers between potential industrialists and investors.

The starting point for a national industrial policy is to alter banking and antitrust regulations to allow the formation of real private investment banks that could devote major amounts of their own resources to industrial investment. Current financial mergers—such as the acquisition of Shearson Loeb Rhoades by American Express—are headed in this direction, anyway, but they need to be encouraged by changes in rules and regulations toward investment banking rather than more and more elaborate systems of consumer finance. With our low savings rates and high usage of consumer credit, America has a banking system that is all too good when it comes to servicing the consumer. What we need is long-run investment funds.

To make a system of industrial banking work it will be necessary to make some changes in our financial regulations. When it comes to representation on boards of directors, we need to follow the German example and collapse the distinction between debt and equity. If an investment bank makes major long-term loans to an industrial firm, it deserves representation on the firm’s board of directors just as if it had made an equity investment. No investment bank is going to make major commitments unless it gets some “hands-on” management and information. There should also be an easy mechanism for converting loans into equity. The combination of these two items would prevent hostile takeover bids from being successful. It would stop management from having to manipulate quarterly profits to keep their stock market price-earnings multiples up and the chances of hostile takeovers down. The time horizons used by management for making investments and developing improved technology could lengthen in a healthy way.

While private investment banks can play a major part in industrial policies, as they do in Germany, it will also be necessary to go beyond private investment banking to publicly backed investment banks. The problem is essentially one of risk. Risks that seem enormous to one firm can seem small if they are spread across all of society.

Moving into new sunrise industries is always risky. If a move requires major amounts of capital, private firms undertake it only slowly and gradually. This is all right if the rest of the world is working on the same principles, but it isn’t. Seventy percent of all robots in the world now work in Japan. With that head start, others are unlikely ever to be able to compete successfully. By recognizing the robot industry as a sunrise industry and backing it with government and private research funds and investment funds, and innovative leasing arrangements, the Japanese have essentially conquered the robot industry before Americans ever realized that it was a potential sunrise industry.

Industrial policies may come under political influence and they may end up backing losers. But this charge is both irrelevant—since we are now in fact backing losers for political reasons, we could hardly be worse off—and easily avoided. Public investment banks or funding agencies for industrial research and development could be limited to taking no more than 50 percent of the risk or putting up no more than 50 percent of the funds. If private partners cannot be found to risk an equal amount of money, the project simply wouldn’t be undertaken.

If you look at the histories of government investment banks abroad, in France, for example, the problem is not that they become “industrial welfare agencies” pouring money into crippled companies, but precisely the opposite. They become so interested in making a profit and being regarded as “sound” financial institutions that they stop being willing to take the high-risk projects that they were originally set up to take. They simply become conservative banks like most private banks. The countries with industrial welfare programs, such as Britain, did not recognize what they were doing; they dealt with every claim for help on an ad hoc basis, and had no general policy of fostering industries with a strong potential for growth. This inevitably leads to “lemon socialism.”

The problem is not to pick the sunrise industries of the year 2000. No one can do that. The problem is to strengthen the industries that are now sunrise industries and to promote cooperation between public and private institutions on research and development projects that might lead to the sunrise industries of the year 2000. In Japan such private-public cooperative research projects are the heart of MITI’s current industrial development strategy. They ought to be the heart of ours since they avoid the charge that government funds are being used unfairly to “subsidize” the research efforts of this or that private firm. Any firm that wants to cooperate in a specific joint research project and is willing to contribute its share of the funds can participate.

To say that Americans cannot run industrial policies—even though as Magaziner and Reich show, others are effectively using them to run us out of business—is simply to say that America’s day in the economic sun is over. It is to admit that we are so administratively and politically incompetent that we must inevitably sink in the economic rankings. Tied for tenth today, but falling to…? tomorrow.