An ‘F’ for Administration Ideology

When my students answer questions on exams, I feel obligated to take them to task for relying on ideological shibboleths rather than thoughtful analysis. But lately I’ve come to question my own prejudices. Increasingly, it seems that smug dogmatism may well be a prerequisite for policy-making at the highest levels of government.

If this Administration were a student in my class at Harvard and I had to grade its recent pronouncements on policies to restore U.S. competitiveness in high-technology industries, here are some of the comments I would make:

1. Free markets are best.

What free markets? High-technology markets have never been free of government intervention in the United States or anywhere else. Governments are deeply involved in protecting and promoting their high-technology producers. Without formal protection and generous subsidies, the Japanese semiconductor and computer industries might not exist. Certainly, they could not have decimated much of the American semiconductor industry, and they would not now be threatening to do the same in computers.

Moreover, when markets are imperfectly competitive--when a few big suppliers dominate world production, as they do in the semiconductor and computer industries--there is no presumption that free market forces will yield desirable outcomes. Even Adam Smith knew this.

And economists as different as Alfred Marshall and Joseph Schumpeter have long realized that free markets under-invest in research and development. Many of our high-tech discoveries would not have been made without generous government support.

Perhaps you should reread the classics.

2. If foreign governments subsidize and protect their high-technology industries, we benefit and they lose.

In the short run, we do benefit from lower prices on foreign goods. But in the long run, it is likely that we will be the losers for two reasons:

First, if the actions of foreign governments force U.S. companies out of business, the result will be a less competitive world industry, in which U.S. consumers depend on foreign suppliers who control both prices and access to new technology. When the industry in question supplies a critical input, such as semiconductors, dependence on a cartel of foreign suppliers threatens our most productive businesses, not to mention our national security.

Those who block efforts to maintain a viable semiconductor industry should recall the disastrous economic consequences of our dependence on a cartel of foreign oil producers in the 1970s.

Second, if we lose our high-technology production base, we will lose not only products, employment and profits but also our innovative capabilities. Technological sophistication is most often an unintended outcome of production; as producers and workers, we develop and refine our innovative skills by solving real production problems. If our high-technology industries erode, so will our skills, which are already deficient because of the atrocious performance of our public education system.

If you are so eager to accept the gift of foreign subsidies, perhaps you should reread “The Iliad.”

3. To restore the competitiveness of U.S. high-technology producers, we have to reduce the cost of capital with a reduction in the capital gains tax.

Reduce the cost of capital, certainly. The cost of capital is significantly higher for U.S. companies than for many of their competitors, especially the Japanese. The higher cost of capital is an important factor behind the “now-nowism” of American businesses and is reflected in their anemic investment performance: In 1989, Japan out-invested us for the first time in history.

Few would deny that America is under-investing. But a broad-based cut in the capital gains tax rate is not the answer. Such a cut would further reduce the tax burden of the very rich--who, despite the tax breaks of the 1980s, failed to save and invest more. It would also encourage short-term stock speculation and reward investment decisions that have little to do with the creation of new capacity.

Instead, if you are serious about the cost of capital, why not consider a sensibly targeted capital gains tax reduction applying only to investments made after the reduction and limited to venture capital and other areas where the social returns exceed the private returns? And why not also consider a tax on the short-term turnover of stocks and other securities that would reduce the speculative pressure on American management to take the short-term view? Finally, why not introduce a targeted investment tax credit--the one tax that has been shown to have a demonstrable effect on productive investment--and broaden the research and development tax credit?

Your attachment to a broad-based capital gains tax cut, even at the risk of exacerbating the budget deficit, suggests either faulty analysis or a hidden agenda.

4. The U.S. government should not pick winners and losers.

But it always has, and with noticeable successes in agriculture, machine tools, aviation, aerospace, semiconductors, computers and biotechnology. Indeed, in most of the industrial activities in which the United States has gained technological pre-eminence, the federal government has played an essential role. And this role has gone far beyond the provision of funds for basic and applied R&D;, to encompass a wide variety of policy tools, including educational and financial support for technological diffusion, procurement, the application of standards and the protection of intellectual property.

And the government continues to pick winners and losers today and does so on a grand scale. During the 1980s, we spent about $134 billion on agricultural subsidies. We recently adopted a bail-out plan for the savings and loan industry with a price tag of at least $175 billion. We continue to promote the residential construction industry by providing large amounts of mortgage tax relief with no income threshold; we are the only major industrial country to do so. And defense spending gobbles up 20% of our manufacturing output.

Instead of reacting with horror to the idea of a few business executives’ laying claim to $100 million of the federal budget to fund Sematech--a cooperative research consortium partly financed by the private sector to build America’s semiconductor industry--we should react with horror to the idea of a few military officials laying claim to $300 billion, including $30 billion for excess inventories of spare parts.

Instead of pretending that government policies don’t “skew the market,” we should modernize our spending priorities to skew it in ways that are more consistent with our long-term interest. Agriculture, housing, a bankrupt savings and loan industry, and a bloated defense budget reflect our past, but they cannot be the foundation of our future strength.

In this class, it’s my job to pick winners and losers; you qualify among the latter.

The American population is not well served by irrelevant homilies on the merits of free markets and ideological cliches on the dangers of picking winners and losers. It deserves a serious and informed debate about the problems of specific industries and about the merits of alternative policy responses. The United States, like the other great superpower, would benefit from some new thinking.

As a first step, why not consider a domestic policy version of Kansas Sen. Bob Dole’s foreign aid plan: Let’s take a small fraction of the money we spend to support past priorities and devote it to future priorities in semiconductors, consumer electronics, computers, biotechnology and superconductivity. There’s always a risk that the money will be wasted; but much of it already is, and the risk of inaction to our well-being is much greater.