By Greg Ip 

President Donald Trump is steering U.S. economic policy in a radically new direction. From trying to revive steelmakers with tariffs to vetoing Chinese technology investments, he is using the federal government to direct which industries prosper and which don't.

Many countries have long tilted the playing field toward favored companies and industries, a practice economists call industrial policy. American presidents have traditionally resisted this as "picking winners."

The president has broken with that tradition, unveiling a series of actions on trade, foreign investment and energy he hopes will revive favored industries and beat back the competitive challenge of other countries -- but which risk creating domestic losers.

His administration pushed strongly for a bill Congress is about to pass significantly expanding Washington's power to scrutinize foreign investment and transactions that could compromise U.S. technological leadership.

These aren't easily labeled a single, coherent policy because they reflect a mix of motives: nostalgia for America's past industrial greatness, devotion to Mr. Trump's electoral base and deep suspicion of China. What they do share is a willingness to override private business and investor decisions in the interests of national security, as Mr. Trump defines it.

Whether they will work is another question. The premise of industrial policy is that the private market doesn't fully value all the benefits some companies and sectors bring the country: their contribution to national security, or to innovation and knowledge that spills over to the broader economy.

In practice, industrial policy goes in one of two directions: one is to prop up mature industries, as Mr. Trump seeks to do with steel and coal. Economists think such efforts cost taxpayers and consumers dearly without altering an industry's long-run fortunes.

The other is to give new industries a leg up against foreign competition. This is what Mr. Trump seeks by stopping China from forcibly acquiring American know how. Many economic and national-security experts back this policy because they see China as a unique threat to the U.S.

"U.S. officials believe China is engaged in economic warfare with the aim of displacing the U.S. as the world's pre-eminent technological and military power," Arthur Kroeber, founding partner at Gavekal Dragonomics, a China economic research service, told clients in January. "Hence the response must go far beyond normal trade tools, and strike directly at China's technological ambitions."

Peter Navarro, Mr. Trump's adviser on trade and manufacturing policy, implicitly echoed that in an interview at a Wall Street Journal conference in June. Every country, including the U.S., pursues industrial policy, he said. "But it's important you distinguish between industrial policies that are predatory, protectionist and mercantilist and industrial policies which are within the bounds of acceptable norms."

Mr. Trump entered office convinced that foreigners had robbed the U.S. of its industrial might, and he would reverse this. "American cars will travel the roads, American planes will soar in the skies, and American ships will patrol the seas, American steel will send new skyscrapers into the clouds," he declared in a campaign speech in September 2016.

It reflected a political impulse with deep roots. In 1791, Alexander Hamilton, George Washington's Treasury Secretary, wrote in his "Report on the Subject of Manufactures" that manufacturers needed government support to overcome entrepreneurs' risk aversion and the advantages other countries gave their producers.

Hamilton preferred targeted subsidies over tariffs, which he thought hurt consumers and sheltered both efficient and inefficient firms. Congress rejected Hamilton's approach, and the U.S. had high tariffs -- though the rates often changed -- until the end of World War II.

Dartmouth College economist and trade historian Douglas Irwin says tariffs didn't accelerate the development of U.S. manufacturing because they were designed to meet political rather than economic priorities. They often ended up helping some manufacturers (those that competed with imports) at the expense of others (those that exported).

After the war the U.S. led a world-wide reduction in global trade barriers via pacts such as the General Agreement on Tariffs and Trade, which became the World Trade Organization. Industrial policy persisted, though, as many countries sought to promote or prop up national champions by nationalizing or subsidizing them or bailing them out.

The U.S. has generally resisted such impulses. During the global financial crisis the administration of Barack Obama did inject money into big banks and car manufacturers because private capital had dried up, but exited those positions as quickly as possible.

Another exception is shipping. In 1920 Congress passed the Jones Act, which requires goods transported between U.S. ports be carried on U.S.-built and -operated ships, to ensure a supply of merchant ships for wartime. A report by the Cato Institute found that the law has made the industry deeply uncompetitive: American-made coastal ships and medium-size freighters cost six to eight times as much as similar foreign-built ships.

The shipping industry has thus declined: The U.S. has only seven active major shipyards, compared with 60 in Europe, and four sell exclusively to the defense department, Cato said. High costs have shifted freight to highway and rail. The average Jones Act-eligible container ship is eight years older than its foreign counterpart, it said.

Matthew Paxton, president of the Shipbuilders Council of America, defends the Jones Act as necessary to protect the domestic industrial base from subsidized Chinese and Korean shipyards.

Echoing the Jones Act rationale, the Trump administration argues steel and aluminum are vital to national defense and thus imposed tariffs of 25% and 10% on them; it is mulling raising tariffs on imported autos and parts as well .As the tariffs have taken effect, booth steel and aluminum companies have begun restarting idled capacity.

But many other industries whose steel inputs have become more expensive say they may have to raise prices or move production abroad. A March report by World Trade Partnership, a consulting firm, concluded the tariffs would boost iron, steel and aluminum employment by 33,000 but reduce all other manufacturing employment by slightly more, led by fabricated metals, motor vehicles and parts, while wiping out an additional 142,000 service-sector jobs. Nor would they actually help national security: Mr. Trump's defense secretary, Jim Mattis, wrote that imports don't impair the acquisition of "steel or aluminum necessary to meet national defense requirements."

The administration is also weighing citing national security to force utilities to buy more power from coal-fired or nuclear generating plants because they store fuel on site, which it claims makes the grid more reliable.

But nuclear and coal power are declining because natural gas and renewables are cheaper, cleaner, or both. One consulting firm estimates the rule could raise customers' costs by up to $12 billion a year without improving grid reliability. A coalition of businesses warned it would undercut the advantage American manufacturers have from cheap natural gas and "result in a substantial loss of U.S. manufacturing capacity and jobs." Nor would it fundamentally improve the prospects of coal mining or coal-generated power. "Frankly, if you find an investor who wants to invest 25 years in coal-fired plants, I would not buy the shares of that company," Patrick Pouyanné, the chief executive of French oil company Total SA, told reporters in June.

While governments have a poor record of turning around declining industries, there is a stronger case for them supporting new industries, particularly by subsidizing early-stage research when commercial payoff is most uncertain. This is especially true in "winner-take-all-or-most" industries in which establishing a successful technology costs a fortune but adding new customers costs almost nothing.

In the 1980s Japan seemed to prove that by vaulting to the front ranks of advanced economies, with the help of technology that American companies such as International Business Machines Corp. and Xerox Corp. had been forced to license to Japanese competitors and a domestic market long sheltered from foreign competition.

Japan's model lost appeal in the 1990s as its economy slumped and the U.S. companies grabbed the lead in internet, software and social media. Still, economists became more receptive to industrial policy and many backed President Obama when he earmarked stimulus funds and rewrote regulations to favor certain sectors, in particular renewable energy.

Then China put Japan's playbook into overdrive. It subsidized key industries, encouraged consolidation to form national champions and forced multinationals to transfer technology to Chinese competitors as a condition of selling to China's vast market. That transfer of technological know-how may have done permanent damage to the U.S., says Rob Atkinson, president of the Information Technology and Innovation Foundation, which is supported by major tech companies.

Tech companies thrive in an ecosystem of specialized suppliers, customers and workers, and once that ecosystem moves abroad, it may never return. "If the dollar goes down a lot, we can probably bring back a boat load of call centers form India. You cannot recreate semiconductors, biotechnology or aviation the same way," says Mr. Atkinson.

That hasn't stopped the Trump administration from trying. It encouraged Taiwan's Foxconn Technology Group to locate a new liquid crystal display factory in southeastern Wisconsin. The state hopes it could become the center of a new Silicon Valley. Even with nearly $4 billion in state and local subsidies and tax breaks, "it's extremely challenging," says Willy Shih, a manufacturing expert at Harvard Business School.

He says Foxconn will have to import almost all of its key inputs except for glass as well as capital equipment and even engineers, and then ship the finished displays thousands of miles to assembly plants in Asia.

A spokeswoman for Foxconn said, "Our strategic partners from Asia and the U.S." will locate their operations to the Wisconsin campus and "seek to source from companies throughout the state."

While trying to bring the technology industry back, the administration is trying to stop even more of it from leaving by taking a much tougher line on Chinese competition. In March the Committee on Foreign Investment in the U.S., a Treasury-led panel that screens foreign investment for national-security concerns, blocked then-Singapore-based Broadcom Ltd.'s hostile takeover of San Diego-based Qualcomm Inc. whose technology is critical to smartphones and the new 5G wireless communication standard.

In a letter, Treasury cited both traditional national security concerns, though it wasn't specific about these, and broader economic worries. It said Broadcom might gut Qualcomm's research and development to generate a quick payback on the takeover. A "reduction in Qualcomm's long-term technological competitiveness and influence in standard setting...would leave an opening for China to expand its influence on the 5G standard-setting process," the letter said. Chinese dominance of 5G "would have substantial negative security consequences."

Congress is about to rewrite the rules governing CFIUS and export controls to better enable the U.S. to block foreign takeovers, minority investments and technology transfers abroad deemed to endanger the U.S.'s long-term technological leadership. "The acquisition of a Silicon Valley startup may raise just as serious concerns from a national security perspective as the acquisition of a defense or aerospace company, CFIUS's traditional area of focus," Heath Tarbert, the Treasury official overseeing CFIUS, told Congress earlier this year. "We must all consider the cost of doing nothing: the potential loss of America's technological and military edge."

The administration is also parrying Chinese technological advance in other areas. In April the Federal Communications Commission barred smaller rural telecommunications carriers from using federal subsidies, worth nearly $9 billion a year, to buy equipment supplied by China's Huawei Technologies Co. and ZTE Corp. U.S. officials have worried the Chinese government could use the equipment to spy on Americans. (The companies deny that.)

Meanwhile, U.S. technology companies are getting another weapon against China: stronger patent rights. In the past, patent owners were sometimes vulnerable to antitrust complaints from competitors who claimed the terms of using their technology were so onerous as to inhibit competition and innovation. Makan Delrahim, head of the Department of Justice's antitrust division, has signaled that the bar will now be higher to hold a patent holder liable for antitrust violations.

This could make U.S. companies less vulnerable to pressure by foreign trust busters to hand their technology over to local firms. In 2015 China forced Qualcomm to pay a fine and slash its royalties to settle antitrust charges. In June a White House report cited this as proof that China uses antimonopoly law to "extort concessions" from American firms.

As with its protection of steel and coal, the administration's protection of American technology companies could impose unintended harm on the economy. Retaliation by China could rob U.S. companies of sales and access to China's growing pool of technology talent. American innovators could be held back if forced to overpay to use patents.

But mistrust of China is intense enough in both parties that even legislators long mistrustful of government intervention are ready to welcome it as a means of holding China back. When ZTE Corp. was caught contravening an earlier settlement for violating sanctions on Iran and North Korea, the Trump administration banned U.S. suppliers from selling it vital components, which could have put it out of business. At Chinese President Xi Jinping's request, Mr. Trump reduced the penalty to a fine and change of management.

Senators from both parties objected and want the penalty reinstated -- not just to protect national security but to counteract China's relentless pursuit of dominance of telecommunications. "In a country full of bad actors when it comes to hurting American jobs and threatening our national security, Huawei and ZTE are two of the absolute worst offenders," said Senate Democratic Leader Chuck Schumer. Added Arkansas Republican Tom Cotton, "I think the death penalty is the right penalty for ZTE's behavior."

Write to Greg Ip at greg.ip@wsj.com

(END) Dow Jones Newswires

July 20, 2018 11:50 ET (15:50 GMT)

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