West Dusts off an Old Idea To Compete With China --- State aid to critical industries, notably tech, makes a comeback

"The U.S. and its allies have long pressed China to stop helping favored industries with subsidies, government preferences and other interventions.

Now they are beginning to copy it. Last month, the U.S. Senate voted for direct industry subsidies with little precedent: $52 billion for new semiconductor fabrication plants, called "fabs."

Other regions have done the same. The European Union has committed to nearly doubling its share of global semiconductor manufacturing capacity, to 20%. South Korea approved up to $65 billion in support for semiconductors, and Japan promised to match other countries' semiconductor aid while planning to turn Japan into an Asian data center hub.

Chip-manufacturing subsidies are the most prominent of a range of interventions Western governments are rushing out to promote industries they deem strategic, from electric-car batteries to pharmaceuticals. Such interventions have increased sharply in both the U.S. and Europe in the past decade, according to Global Trade Alert, a trade-monitoring group.

Collectively, this represents an embrace of "industrial policy," the idea that governments should direct resources to industries critical to the national interest rather than leaving things to the market.

Advocates say the U.S. has employed industrial policy in some form ever since its first treasury secretary, Alexander Hamilton, used tariffs to nurture manufacturing. Critics call it "picking winners" in ways better left to capital markets, and point to money wasted on past efforts such as supersonic airliners and fast breeder nuclear reactors.

Support now is broadening, straddling the Trump and Biden administrations, driven by pandemic-driven disruptions to supply chains and the rise of China. American officials once assumed that as China's government matured, the state's role in the economy would shrink. Now they say the U.S. has to embrace government intervention or watch China dominate.

"I've been impressed with the Chinese model," said Mark Warner, a former venture capitalist and Virginia governor who as a Democratic senator sponsored the semiconductor legislation. The Chinese state ensures that Chinese, not foreign, companies become the dominant players in its domestic market, effectively guaranteeing them a big share of the world's market, he said.

"It's hard to see how a company in America or any normal, traditional market-based economy can compete against that kind of juggernaut and win," Mr. Warner said.

The biggest hurdle with industrial policy is governments' inability to predict technological trends, and the West's new industrial-policy push might prove wasteful and ineffective, which some analysts say is already true of China's.

"It would be a huge mistake for the U.S. to try and match Chinese government spending," said Scott Kennedy of the Center for Strategic and International Studies, a think tank. "So much of it is thrown down bottomless pits, leading to over-investment, lower profits, slower innovation and more debt."

Industrial policy was once commonplace among market-based democracies. Western European governments held controlling stakes in numerous companies. Japan's Ministry of International Trade and Industry, or MITI, influenced almost every major industry decision.

They pulled back over recent decades. European governments privatized state-owned enterprises. MITI's influence shrank in the 1990s in the face of deregulation and the collapse of Japan's bubble economy.

China, though, never retreated. Even after it introduced market reforms in 1979 and accelerated them after 1992, the state continued to guide economic development through ownership of enterprises and control over credit, government purchases, tax preferences, land and foreign investment. Since 2006 the Communist Party has put priority on catching up to the West technologically.

China is responding in part to the Trump administration's barring U.S. companies from supplying critical technologies to Chinese companies such as telecom manufacturer Huawei Technologies. The prospect of China's doing the same -- made more urgent by many countries' restrictions on exports of medical supplies during the pandemic -- has led some skeptics to swallow their reservations about industrial policy.

Sen. John Cornyn, a Texas Republican who co-sponsored the legislation with Mr. Warner, said, "What we're doing is industrial policy unlike anything people with my free-market, conservative background would ordinarily be comfortable with. Our driving impetus is what China is doing and [the security of] the supply chain."

Current industrial-support efforts are narrower than in the past. Japanese officials say government intervention should be the exception, focusing on "chokepoint" sectors critical to others. A June document from its Ministry of Economy, Trade and Industry, the successor to MITI, described semiconductors as the "brain of industry," as essential as energy and food, and as meriting an exception.

In 2014, the EU said exceptions could be made for "important projects of common European interest" that have widely shared benefits and don't distort competition. One is the European Battery Alliance, a public-private consortium with more than 600 members that is developing batteries for electric vehicles and power grids.

In U.S. there has long been broad support for government funding of basic research and development. One result is that the U.S. still leads in inventing and designing new technology, even though the manufacture of the resulting products moved abroad, mostly to East Asia.

The U.S. led in the development of photovoltaic solar technology, but China dominates the manufacture of their panels. U.S. companies account for half of world semiconductor-design revenue, but U.S. factories make just 12% of semiconductors.

Advocates of industrial policy in Congress and the White House are no longer satisfied simply promoting innovation; they want the products to be made in the U.S. They have multiple goals: to secure U.S. supply, create jobs and ensure that the resulting intellectual property stays in the U.S. rather than being transferred to Chinese competitors via outsourcing.

Last month, the White House proposed a breadth of tools to boost domestic production in four sectors deemed vital to the supply chain: semiconductors, batteries, specialized minerals and pharmaceutical ingredients.

It proposed using several existing federal loan, tax-credit and R&D programs to support electric-vehicle battery manufacturing. To reduce dependence on foreign supplies of neodymium magnets, important components of motors and other devices, it suggested imposing tariffs under the same 1962 national-security law that former President Donald Trump used to impose tariffs on imported steel and aluminum.

The administration also announced plans for a public-private consortium to revive domestic production of 50 to 100 drugs, as well as plans for a lithium-battery supply chain.

The return of industrial policy complicates life for businesses. The U.S.-China trade war had already led to tariffs and export controls. Now, industry officials say, decisions previously based on cost and proximity to customers, suppliers and the head office must also take into account political pressure to localize production.

Last year the Trump administration helped persuade Taiwan Semiconductor Manufacturing Co., the world's largest chip foundry -- a company that makes chips designed by others -- to build a fab in Arizona.

"We conveyed to TSMC the importance of securing the semiconductor supply chain, and that the U.S. government as well as their U.S. customers wanted them manufacturing here," said Keith Krach, who led the negotiations as a State Department undersecretary at the time.

TSMC said the Arizona fab is "of critical, strategic importance to a vibrant and competitive U.S. semiconductor ecosystem."

The arrangement also needed to make economic sense, Mr. Krach said, so obtaining congressional authorization for incentives to TSMC was a key reason the Trump administration pushed for the legislation providing aid to the chip industry. The House has yet to take up the Senate-passed bill.

Efforts by the U.S. and its allies to build up industries that can challenge China face several obstacles to success. One is that China's commitment to industrial policy is deeper and older.

Its support for favored industries is pervasive and opaque, and difficult to challenge as a violation of international trade rules. By restricting the export of raw aluminum, China ensures manufacturers have a cheap supply of material, said Chad Bown of the Peterson Institute for International Economics, a pro-free trade think tank.

Western governments are reluctant to take ownership of industrial companies, but doing that is central to China's industrial policy. Not only are many of its largest companies state-owned, but Chinese governments at all levels have established 1,741 industrial guidance funds -- in effect, state-sponsored private equity -- with plans to deploy $1.6 trillion, according to Georgetown University's Center for Security and Emerging Technology, a research center.

Government support from 2014 to 2018 was equal to as much as 30% or more of annual revenue for two of China's two major semiconductor companies, Semiconductor Manufacturing International Corp. (SMIC) and Tsinghua Unigroup, according to the Organization for Economic Cooperation and Development, an association of mostly advanced economies. Other countries subsidize semiconductor fabs through cheap land and tax breaks, but only China provides so much aid in the form of this cheap equity, the OECD said.

Whether China's spending is effective remains controversial. Chinese chip companies remain behind leading Western competitors. Mr. Kennedy of CSIS estimated China has injected between $49 billion and $72 billion into state-owned aircraft maker Commercial Aircraft Corporation of China (Comac) in a so-far-unsuccessful effort to make it a competitor to Airbus and Boeing.

Even if other countries spent as much as China, they would likely struggle to achieve truly independent supply chains because China dominates so many of the links. When semiconductor chips are fabricated in the U.S. they still must undergo assembly, packaging and testing, a low-margin business where China is the biggest player.

In the 1980s the U.S. imposed restrictions on imports from Japan of dynamic random access memory (DRAM) chips to protect U.S. market share, but DRAM chips became a commodity business whipsawed by booms and busts. Production has almost entirely left the U.S.

Mr. Warner knows the lesson well. As governor of Virginia, he, like two predecessors, directed state aid to a memory-chip plant just outside Richmond operated by a spinoff of Germany's Infineon Technologies AG. In 2009, amid a global glut driving down memory-chip prices, the spinoff entered bankruptcy protection and closed the facility, laying off more than 1,000 employees.

Mr. Warner said U.S. semiconductor subsidies must be allocated through a clear, rigorous process without political interference. But "the truth is you could have a panel that makes exactly the right decisions, technology could leapfrog and, five years later, the valid choices made in 2021 could look pretty stupid," he said.

Mr. Warner said the U.S. has little choice because semiconductor fabs are going to be built and without federal intervention they'll go to China. "I was a venture capitalist before I was a politician," Mr. Warner said. "This is the kind of bet America has to make."" [1]

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1. West Dusts off an Old Idea To Compete With China --- State aid to critical industries, notably tech, makes a comeback
Ip, Greg. Wall Street Journal, Eastern edition; New York, N.Y. [New York, N.Y]30 July 2021: A.1.