The benefits outweigh the harm when rich countries race their economies inward
The trend of inward-looking economics (homeland economics) - bringing production home, racing to dominate strategic industries in rich countries, can create more trouble for the world, according to the Economist.
After the Cold War, globalization took hold in the 1990s, thanks to a belief in the power of free markets. Countries loosen controls on travel, investment and trade. In 2001, China joined the World Trade Organization, promoting trade between Asia and the West. The changes bring many benefits, reducing poverty and inequality.
However, recently, globalization has slowed down. Britain voted Brexit (leave the European Union). Then, the US-China trade war broke out. But basically, globalization continues. However, a radical alternative to globalization is now truly emerging.
The Economist calls it "homeland economics", with the main idea being to find ways to minimize risks to a country's economy. Risks include erratic market fluctuations, shocks such as pandemics or moves by political opponents.
Inward-looking economics is a response to four major shocks the world has experienced. First is the economic shock.
If the 2007 - 2009 financial crisis shook the old model, the 2020 global recession has clearly collapsed confidence. Covid-19 causes supply chains to break down, increasing inflation. A system that once seemed to offer efficiency and convenience has turned into a source of instability. The pandemic has also boosted people's belief that the government should intervene in the economy more.
The second shock is geopolitical instability. The controversy between the US and China has not subsided and both sides use a series of economic countermeasures. The largest land conflict in Europe since 1945 is taking place in Ukraine. The notion that economic integration will lead to political integration is no longer there.
The third shock is energy. Russia's cut off of European gas supplies makes many politicians think that it is necessary to ensure alternatives, not only in energy but also in terms of strategic goods in general.
And fourth is the artificial intelligence (AI) shock, which can pose a threat to workers.
Domestic economies want to avoid similar shocks in the future and retain the benefits of globalization such as efficiency and low prices. To do this requires combining economic and security policies.
"I want to start by thanking all of you for inviting a national security advisor to discuss the economy," Jake Sullivan, US National Security Advisor, said in Washington DC in April. His thanks signaled that control of the economy had passed to geostrategists.
Other leaders made similar statements. Ursula von der Leyen, President of the European Commission, is proud that the European Union (EU) is "the first major economy to propose a strategy on economic security". French President Emmanuel Macron mentioned "strategic autonomy". Indian Prime Minister Narendra Modi talked about economic "autonomy".
For implementation, several old tools were reused. Some of President Donald Trump's 2018 tax increase decisions resemble America's 1930s protectionist policies. But the real focus is on many governments hoping to become champions in strategic industries such as computer chips, electric vehicles and AI.
Therefore, they launched huge subsidies with domestic content requirements to encourage domestic production. As during the Cold War, Western governments use economic tools to weaken geopolitical rivals, including international export and investment bans, especially when it comes to "dual-use" technology, meaning it can be applied to civil and military applications.
US President Joe Biden speaks after visiting the Ford Rouge Electric Vehicle Center in Dearborn, Michigan, May 18, 2021. Photo: Reuters
Under President Joe Biden, the US implemented the CHIPS Act to support the domestic semiconductor industry and the Inflation Reduction Act (IRA) to subsidize green energy. Both aim to build jobs and expertise in the country.
The EU implemented the "Green Deal Industrial Plan". Recently, 14 EU member states established a plan to support microelectronics and communications technology. France deploys fund for production of important minerals. The EU wants 40% of key technologies needed for the green transition and 20% of the world's semiconductors to be produced in the bloc.
India launches production-linked incentive program for many sectors, including advanced solar photovoltaic module and battery manufacturing. Under the K-chip Act, Korea gives tax incentives to semiconductor companies. Inspired by the "Made in China" program that started in 2015, the world now has "Made in America", "Made in Europe", "Make in India", "Made-in-Canada plan" and "A Future Made in Australia".
Research by a group of experts including Réka Juhász (University of British Columbia), Nathan Lane and Emily Oehlsen (Oxford University), Verónica C. Pérez (Boston University) said that in the past, poor countries only used industrial policy to develop. However, today rich countries account for the majority of industrial policy launches, with a spike in 2021-2022.
According to data analysis by the Economist , interest in industrial policy is rising in political messaging. Officials are willing to spend money to persuade businesses to locate or expand operations in their countries. In the first quarter, businesses in rich countries received about 40% more subsidies than normal in pre-pandemic years.
In the second quarter, the US spent 25 billion USD on subsidies. According to UBS bank, G7 governments plan to spend up to 400 billion USD on the semiconductor industry in the next decade. Since 2020, governments have allocated $1,300 billion to support investment in clean energy.
US spending on industrial policy relative to GDP may still be far behind China's, but it is on par with France. The British Labor Party, if it wins power, will want to spend billions of dollars on green grants, which as a proportion of GDP will be 10 times higher than the US. After investing in semiconductors, policymakers are targeting quantum computing and AI.
Businesses are adapting. CEOs mention "bringing production back home" more often. Investors are also excited. According to data from Goldman Sachs, since the beginning of 2022, the average stock price of US companies "considered to benefit from additional spending on infrastructure" has increased 13%, compared to a 9% decrease in the entire US stock market.
A lot about inward economics seems reasonable. Who can argue against making supply chains resilient, helping left-behind regions, rebuilding the energy mix? "There are solid theoretical and economic bases for industrial policy," said a group of Harvard University experts.
These policies will create many winners, from the bosses of the companies that receive incentives, to the investors in those companies, to the regions that benefit from the new factories. However, the Economist argues that it also creates billions of "losers". Because underneath the rationality lies incoherence.
The benefits of an inward-looking economy are exaggerated by pessimists about globalization, which in fact brings enormous benefits to most of the world. Meanwhile, the new benefits are uncertain and efforts to economically disengage from China are likely to be localized.
On the contrary, the loss is clear. The IMF has a study that considers the assumption that the world has divided into blocs led by the US and China. In the short term, global output is 1% lower and in the long run 2% lower. Other estimates put the impact on global GDP at over 5%.
Based on analysis from many predominantly wealthy countries, historical experience with industrial policy is also not encouraging. India's "production-linked incentive" program, for example, pays manufacturers a sum for each unit produced. After the program was launched, mobile phone exports skyrocketed.
However, a recent study by three economists Rahul Chauhan, Rohit Lamba and Raghuram Rajan showed that mobile phone imports also skyrocketed. Perhaps the manufacturers are simply re-exporting the phones to India to receive subsidies.
This year Lightyear, the Dutch solar car company supported by the government and the European Commission, ran into financial difficulties and stopped production. Britishvolt, the electric battery company that the British government pledged to support, also collapsed. Efforts to promote the US chip industry are also not favorable. Production at the first factory in Arizona will be delayed until 2025 due to a lack of specialized workers, TSMC Founder Morris Chang said.
Meanwhile, economic costs are emerging, as a result of retaliation. Recently, China imposed export controls on gallium and germanium. China produces 98% of the world's crude gallium, a key ingredient in advanced military technology. In February, it placed Lockheed Martin and a subsidiary of Raytheon, two US arms manufacturers, on its unreliable list.
In addition, governments may waste a lot of money in a context where they need a lot of resources for health care, pension payments and public debt repayment. The UK National Audit Office report notes that the "governance and implementation structures" behind the $5.2 billion net-zero package need to be improved, and "there is a risk that the government will not achieve either greenhouse gas or economic targets, or provide value for money." With an average budget deficit of 4% of GDP in rich countries, can everyone afford to pay the price for such mistakes?, the Economist asked.
There is also a downside called "hidden damage". The most prominent benefits of the inward-looking economic model are still political. Governments boast of subsidy successes, from Tata's new car battery factory in the UK to the new Rapidus chip factory in Hokkaido with support from the Japanese government. But lower income and less efficiency will cause widespread damage, difficult to notice and easily overlooked. "By promising things they cannot keep, politicians are accumulating trouble," commented the Economist .