President Biden’s State of the Union address was dense in economic fallacies. Perhaps the most glaring one was the idea that we can change the nature of American prosperity. Traditionally, it was driven by upstarts, from immigrants to clever people in Silicon Valley taking risks and not only getting rich themselves but also making America richer, too. Biden has a different vision, one where the government directs investment, resulting in more productivity, less inflation, and prosperity for all—with no excessive gains or losses for anyone.
In financial markets, a clear and natural trade-off exists between risk and reward. If you invest in riskier assets, you can expect to earn higher returns most of the time, though you also are subject to losses. This is not just the natural law of financial markets; it holds for the entire economy. America has become a global economic leader in part because its institutions support risk-taking—from its financial markets, which allocate and price capital for uncertain new ventures, to its bankruptcy laws, which allow people to take bets on improving their lives.
Now Democrats are testing this proposition. Biden last night claimed that he can make drugs cheaper, even though high drug prices often reflect the considerable financial risk that pharmaceutical companies take on. He claimed that government investment in industry and reshoring manufacturing will deliver riskless growth. This is also the idea behind the America Competes Act, recently passed by the House of Representatives, which envisions an economy where the government directs innovation by allocating capital to certain industries and reducing global trade.
Odds are the Democrats’ plan won’t work. The new bill and liberal commentators’ accompanying calls for an industrial-policy supply-side revolution are both based on the notion that if the government would only get more involved in the economy, we would experience more growth with less downside risk. The America Competes Act attempts to do this by pouring more money into scientific innovations that would benefit favored projects and by adding more subsidies, tariffs, and export controls in industries that are both politically popular and allegedly necessary for our long-term security. In the bill’s 2,900 pages, some useful programs emerge, such as support for STEM education, but most of it reads like the standard sort of industrial policy with a long history of failure.
President Biden is on record saying that the U.S. should emulate aspects of the Chinese economic model, in which the government takes a heavy hand in determining which industries should thrive. At first glance, the model does seem to work: China has enjoyed sustained, stable, and fast growth for decades. But such performance is typical of economies that merely adopt and build on existing foreign technology. Whether China can truly innovate with the government picking projects and diverting capital to wasteful investments remains to be seen. One can point to some successful examples of governments directing capital, like Operation Warp Speed, but these are the rare cases where the need for the innovation in question was obvious and didn’t involve picking winners or predicting the future.
Usually, the best innovations for driving growth come from unlikely or unexpected places, which is what makes the process inherently risky. The problem with industrial policy is that it gives certain industries subsidized capital, which offers them the potential for profit while offloading risks to taxpayers. This not only has the potential to divert capital and talent from productive uses but also distorts the price of capital, making it a less meaningful market signal for innovations in other parts of the economy.
The America Competes Act also attempts to reduce the global supply-chain vulnerabilities that the pandemic exposed and to bring more manufacturing jobs back to the United States. Again, there is no free lunch here. Global supply chains are very efficient, which means lower prices for both producers (who rely on it for intermediate goods) and consumers. It is indeed risky to rely on a single country for goods—Taiwan’s global dominance in semiconductors comes to mind. But the answer to this problem isn’t subsidies that distort global prices and protect U.S. industries from global competition. This will only make them weaker and goods more expensive for American consumers.
The Biden administration might argue that the America Competes Act will build resilience. But the idea that we can make everything domestically, at all stages of production, would come at a steep price—one not worth paying. Reducing risk is expensive, whether one is hedging an investment portfolio or building a self-contained domestic manufacturing sector. Less trade would undermine long-term resilience. The best way to build resilience is diversification among many producers around the world.
It’s tempting to think that we can steer growth while eliminating shortages, bankruptcies, and recessions, no matter what shocks the economy has in store. But encouraging risk—not trying to control it or get rid of it—is what made the American economy successful.
Photo by Jemal Countess/Getty Images for Green New Deal Network