Subsidies and tariffs waste resources, burden taxpayers and politicize decisions best left to the markets. No wonder economists praise free trade.
Shifting production of semiconductors and myriad other products to China may be economically efficient, but it comes with a downside: the potential for China to use that dependency in a future conflict with the US or its allies, just as Russia is now using Europe’s dependency of his gas to undermine support for Ukraine.
In a recent speech in South Korea, Treasury Secretary Janet Yellen, an economist, referred to this risk as “externality,” which refers to costs that an economic transaction imposes on others, such as pollution from a factory. Trade policy, she said, should “consider externalities arising from concentration of supply chains, geopolitical concerns and value — rather than focusing too much on costs.”
Sen. Todd Young (R., Ind.), a major sponsor of Senate legislation that earmarks $52.7 billion for US semiconductor manufacturing and billions more for research and development, agreed, “The real world circumstances are rich more complicated than the economic models I learned at the University of Chicago, which have become more complicated with the emergence of our competitor and his state-capitalist economic model.”
Subsidies and tariffs are usually intended to protect domestic industry and jobs from foreign competitors or to give them an advantage in foreign markets. More than two centuries ago, Adam Smith wrote The Wealth of Nations, in part to discredit protectionism. But he made an exception for national security reasons, for example defending laws requiring British ships to carry British imports. “Defense is far more important than opulence,” he wrote.
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The events of the last few years have drawn renewed attention to the threat to supply chains. The pandemic led to an acute shortage of semiconductors and affected automobile production. Some countries restricted the export of medical products or goods. Geopolitics has often been a driver: the US restricted sales of sensitive technology to Chinese companies and joined its allies in blocking sales of key products such as microchips and airplane parts to Russia for its invasion of Ukraine. Russia is reacting in kind and is holding back natural gas supplies to Europe. It’s not hard to imagine that in a future conflict over Taiwan, China could withhold vital supplies from any country thinking of coming to its aid.
“Bilateral tariff wars don’t really do much,” said Sen. Todd Young (R., Ind.), one of the main sponsors of the Senate bill. “But… shifting sourcing to a friendly country, that might not be a bad thing.”
Photo: Chip Somodevilla/Getty Images
Critics of subsidies to build semiconductor factories, or “fabs,” in the US, such as Senator Bernie Sanders (I, Vt.), note that their likely recipients, such as Intel Corp. and Taiwan Semiconductor Manufacturing Co. are tremendously profitable. The harsh reality is that almost every host country subsidizes factories, no more so than China. Otherwise, the USA will tend to lose out when it comes to future location decisions.
When industrial policy is back in fashion, other industries will declare themselves eligible. But the bar is set high, judging by the circuitous, two-year journey of this bill. “Someone would have to make a strong case that other countries are subsidizing a particular industry and preventing the US from making mission-critical components available to our companies,” Mr. Young said. House Democrats once tried to add $45 billion in subsidies to other American industries. Senate Republicans, including Mr. Young, said no. The House of Representatives is now expected to approve the Senate bill.
The European Union is also increasing semiconductor subsidies, raising the prospect of a subsidy war and a capacity glut. In response, the US and EU say they will coordinate. “We have a common interest in not organizing a subsidized race,” said Margrethe Vestager, EU Commissioner for Competition, in an interview earlier this year. For both Europe and the US, semiconductor self-sufficiency is “a no-go” and requires funds and talent that don’t exist, she said. “So we think the only way forward is for the EU and the US to work together, probably with other partners as well.”
The biggest shortcoming of the bill is how little it reduces dependence on China. Attention to cutting-edge fields like robotics and artificial intelligence is obscuring China’s hold on mundane but critical products like dyes used in magnetic resonance imaging and neodymium magnets. Even as the US and its allies dominate advanced chips such as those used in data centers, China is expanding its market share in low-end chips, which are critical to numerous industries, including autos. This will remain so as long as China can ignore profits while Western companies cannot and therefore have no incentive to diversify into more expensive suppliers.
Tariffs provide an incentive. While Mr. Trump imposed tariffs on most Chinese imports in 2018, primarily to reduce the US trade deficit, another goal was to force US companies “to consider other options for manufacturing these goods,” Matt Turpin said , who served at Mr. Trump’s National Security Council and is now associated with the Hoover Institution, a think tank.
The tariffs did not shrink the overall US trade deficit as the free traders had predicted. But they seem to have expanded U.S. imports from Mexico, South Korea and Vietnam at the expense of China, according to various studies — which could have benefits free traders don’t consider. “Bilateral tariff wars don’t really do much,” said Mr. Young. “But… shifting sourcing to a friendly country, that might not be a bad thing.”
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