The Future of Innovation: Should the U.S. Copy China’s Industrial Policy?

By Adam Thierer and Connor Haaland

Calls for revitalizing American industrial policy have multiplied in recent years, with many pundits and policymakers suggesting that the U.S. should consider taking on Europe and China by emulating their approaches to technological development. The goal would be to have Washington formulate a set of strategic innovation goals and mobilize government planning and spending around them. While the European Union’s track record of building national technology champions is a seemingly endless string of failed initiatives, China appears to be a more formidable model. But as Matt Ridley notes, much of China’s innovation success is attributable to hard work, expanded trade and an increasing openness to entrepreneurialism. “So long as they are not trying to invent democracy, or a new political party, innovators are surprisingly free to try anything,” he argues. “A Chinese entrepreneur faces almost none of the delays and restrictions that a Western one does.” Others insist that China’s aggressive efforts to promote key sectors and national champions is what has given the country a leg up on global competitors. They assert or imply that the U.S. will need to move toward highly targeted industrial development so that it can compete in strategic sectors such as semiconductors, 5G and artificial intelligence.

Students in Chengdu, China watch a robot doing tai chi last November. Image Credit: TPG/Getty Images What they miss is that China’s targeting efforts are often antithetical to both innovation and liberty, and involve plenty of red tape and bureaucracy. China has become a remarkably innovative country for many reasons, including its greater tolerance for risk-taking, even as the Chinese Communist Party continues to pump resources into strategic sectors. But most Chinese innovation is permissible only insomuch as it furthers the party’s objectives, a strategy the U.S. obviously wouldn’t want to copy.

The Big Plan

“It is past time for the U.S. government to get over the allergic reaction to ‘industrial policy,’” argues Carolyn Bartholomew, chair of the congressionally chartered U.S.-China Economic and Security Review Commission. She deserves credit for at least using the term. It is increasingly the case that, much like Fight Club, the first rule of industrial policy is you don’t talk about industrial policy. The term has been sullied enough over time that many proponents now rebrand it as “strategic innovation policy” or “national industrial strategy,” among other monikers. Regardless of what it’s called, all roads lead back to “a big plan,” and responding to China’s big plans has been the driving force behind calls for American equivalents. For example, on March 2, the congressionally authorized National Security Commission on Artificial Intelligence released a report outlining ways to counter China on the AI front. While carefully avoiding mention of industrial policy, the report takes an everything-and-the-kitchen-sink approach to state direction with a whopping 756 pages of detailed recommendations for new AI-related efforts and spending. The authors argue that the time has come to “drive change through top-down leadership” in the U.S., and they insist that “we must win the AI competition that is intensifying strategic competition with China.” They don’t shy away from the price tag, advocating $40 billion in new government AI investment immediately and then casually suggesting that “hundreds of billions in federal spending in coming years” will be needed to support other initiatives. The report is essentially an American response to the CCP’s Made in China 2025 strategic plan that was issued in 2015 and aspired to make China a global leader in many manufacturing sectors, including robotics and AI. The commission’s report also tracks China’s 2017 AI Development Plan, which is as much a manifesto about geopolitical power as it is a plan for targeted industrial development. “We take seriously China’s ambition to surpass the U.S. as the world’s AI leader within a decade,” the authors say. But less attention is being paid to how America became the world’s AI leader in the first place without such a top-down industrial policy. The assumption is that a big plan is the key to strategic success in countering China’s grandiose ambitions. Implicitly, anyone who doesn’t have a big plan of their own apparently isn’t taking the China threat seriously.

“Japan, Inc.” All Over Again?

Not everyone agrees that the China threat is so significant, however. Some policy experts such as Daniel Drezner, professor of international politics at the Fletcher School of Law and Diplomacy at Tufts University, argue that “there is no China crisis” and that “the current freakout” over China’s growing might is unwarranted. There are some good reasons to be concerned about China’s growing economic power relative to the U.S., but he notes that we heard similar lamentations in the last century about the Soviet Union and then Japan overtaking us economically. The Japanese comparison is particularly apt, at least regarding Chinese industrial policy efforts focused on specific technologies. “After four decades of rapid growth, [Japan] seemed poised to overtake the U.S. economically,” Drezner says. But then its economic planning model imploded rather abruptly. The Nikkei stock market index peaked on the last trading day of 1989 before plummeting for much of the next 30 years, and still has never come close to regaining its record level. Throughout the 1980s and early 1990s, just as in recent years, American pundits and politicians were decrying de-industrialization, trade deficits and job losses in certain sectors. Their primary fear then was how the U.S. was supposedly losing ground to Japan. Industrial policy advocates claimed that Japan had adopted targeted schemes that would leave the U.S. behind in the race for technological global advantage. At the time, book titles asked Can America Compete?, while Clyde Prestowitz suggested that the U.S. was Trading Places with Japan. He argued that if the U.S. did not reverse course and adopt the Japan model, America risked becoming an economic “colony‐in‐the‐making.” Congressional hearings and government reports featured repeated warnings that the U.S. needed to follow Japan’s example and pay attention to how “the emphasis of industrial policy has shifted from industry-specific to technology-specific targets.” The Japan model that proponents advocated back then sounded much like what is heard today about China: Generous (and highly targeted) research and development investments, Tokyo-led public-private consortia, mercantilist trade policies (export assistance plus restrictions on imports and foreign investment), and other forms of targeted government support for specific sectors or new technology initiatives. By the late 1990s, however, most scholars viewed Japan’s strategy as a costly bust. In 2007, Marcus Noland of the Peterson Institute for International Economics summarized Japan’s industrial policy experience in bleak terms, noting that despite all its efforts, “Japan faces significant challenges in encouraging innovation and entrepreneurship. Attempts to formally model past industrial policy interventions uniformly uncover little, if any, positive impact on productivity, growth or welfare.” Worse yet, Noland noted that most of the assistance “went predominantly to politically organized, declining sectors” and that “corruption was encouraged by the policy-instigated creation and distribution of rents.” There were other unfortunate consequences of government intervention. Most notably, “financial sector repression and directed capital policies encouraged a bureaucratization of banking,” and “bankers did not develop the necessary skills to evaluate alternative business plans and models.” Public intervention and spending had crowded out not just private financing, but also the development of private financing capabilities. Meanwhile, the U.S. was racing ahead, fueled by a vibrant venture capital market and friendly policies for risk-taking and entrepreneurship. A 2015 report on “The Economic Impact of Venture Capital,” noted that of 1,339 public U.S. companies started after 1974, 42% were VC-backed. The study also found that VC backing had a major impact on R&D spending, “with VC-backed firms making up an overwhelming 85% of the total R&D of the post-1974 public companies.” Those companies are the ones that helped the U.S. take a dominant position in the information revolution over the past quarter-century.

Downsides of the China Model

If the U.S. has anything to learn from today’s Chinese model it is that innovation pursuing the goals of the state is not permissionless innovation at all. It's just a techno-authoritarian industrial policy that is subservient to governmental domestic and geopolitical objectives and can be switched off at the whim of politicians and bureaucrats.

Alibaba Group founder Jack Ma. Image Credit: Wang He/Getty Images

Ask Jack Ma how the Chinese model has worked out for him lately. The renowned entrepreneur and founder of Alibaba, the world’s largest e-commerce company, had not been seen for two months until finally resurfacing. He was lying low after criticizing the CCP in October on how the government’s expanding financial regulations were holding back technology development and innovative upstarts. In speeches Ma stressed how this could limit China’s growth. “The financial industry needs disrupters,” he said. In response, the CCP issued major new regulations aimed at disrupting Ma’s Ant Group and began an antitrust investigation into Alibaba. In China you can be innovative but only if it furthers the interests of the CCP.

Moreover, industrial policy is no free lunch, as the Chinese are now learning. Just this week, the Wall Street Journal detailed how the CCP is struggling to deal with the sprawling red tape created by the compounding effects of the country’s many ambitious five-year plans. The party has even created new disciplinary measures to penalize “formalism” and “bureaucratism” offenses and has punished more than 100,000 people for violating the rules. Unsurprisingly, “proposed remedies seem only to encourage more bureaucracy,” the story concludes.

Better Approaches

U.S. advocates seem undeterred, however, by the pitfalls of a heavy-handed, Chinese-style industrial policy. Jake Sullivan, now national security adviser for President Biden, co-authored an article early last year advocating an industrial policy that “rather than focusing on picking winners in specific sectors… should focus instead on investing in large-scale missions—like putting a man on the moon or achieving net-zero emissions—that require innovations across many different sectors.” Again, none dare call it industrial policy! But there is a fuzzy line between government promoting strategic goals and it taking steps to promote specific technologies or sectors. If the goal is to make the U.S. economy more competitive, there are many sensible approaches that are far better than industrial policy schemes. Beyond relying on our vibrant venture capital market and a general freedom to innovate, the U.S. can provide more support for basic R&D, federal laboratories and university research centers. The government can also continue to embrace prize competitions instead of expecting bureaucrats to try and divine which companies or ideas should receive funding. With prize competitions, governments can set broad goals to help facilitate the effort to meet important societal needs but then get out of the way. The competitions and prizes then create a powerful incentive for innovators to pursue those goals, not only to win money, but by also gaining recognition from peers and the public. An example of this is how the government created a competition to spur the development of driverless cars. The Defense Advanced Research Projects Agency launched the Grand Challenge competition to encourage autonomous vehicle technologies. While no team claimed the $1 million prize in the competition’s first year in 2004, the following year the Stanford Racing Team won the $2 million prize by beating five other teams. Many of the innovators involved in the original competition still work on driverless cars for leading innovators in the field. During the Obama years, the use of competitions expanded. In 2010, President Obama signed the America Competes Reauthorization Act, which granted federal agencies the power to create prize competitions. He later signed the American Innovation and Competitiveness Act, which expanded the incentive-prize authority, and then also created the Challenge.gov web portal, which brings together the various federal prize competitions or crowdsourcing efforts.

Attract Talent, Continue To Trade

These strategies may be more effective in sparking innovation than the retaliatory-minded “get tough” approach many have advocated in recent years. This has meant slapping tariffs on Chinese goods, talk of decoupling from China and a trend toward isolationism, especially during the Trump years. Dan Yang, a Chinese technology analyst, has noted the shortcomings of this strategy. “For the most part, the control hawks faction of the government has had a run of the table, shown by the fact that U.S. agencies have been more focused on taking down Chinese firms than extending U.S. strengths,” he noted late last year. But this is counterproductive in the long run: “The U.S. responded to the rise of the USSR and Japan by focusing on innovation,” whereas “so far the U.S. is responding to the technological rise of China by kneecapping its leading firms. So instead of realizing its own Sputnik moment, it is triggering one in China.” Meanwhile, at a time when technical research capabilities at U.S. universities need to grow, the government has been making it harder for them to bring in students and instructors. Last year the number of foreign students enrolled in U.S. colleges fell slightly. This points to perhaps the most crucial policy stance the U.S. can take to counter China. As Caleb Watney, director of innovation policy at the Progressive Policy Institute, has shown, following World War II, America was the undisputed leader in scientific and technological research because it was an active recruiter of global talent. When the best and brightest minds mix their ideas and cultures, innovation and prosperity follow. We need to ensure our immigration laws don’t discourage the inflow of innovative minds. Business leaders generally understand this. A recent Brookings Institution survey of 158 senior business executives revealed that leaders at both Chinese and U.S.-based companies “chose doubling down on globalization as their primary recommendation,” with 53% recommending that the U.S. adopt policies that “encourage global companies to invest in the U.S. and encourage global technical talent to live and work in the U.S.” By comparison, just 9% prioritized increased federal research funding, and only 7% listed heavy direct subsidies for tech as the best approach.

Smart Ways To Counter Mercantilism 

Of course, the CCP will continue to engage in innovation mercantilism and techno-authoritarianism. Open and free countries cannot turn a blind eye to it completely, and many of them are now considering possible collective responses. The Wall Street Journal noted last month that the Biden administration has been formulating a “pragmatic approach of cobbling together groups of countries to work jointly on technology. The goal is to stay ahead of China in semiconductors, artificial intelligence and other advances that are expected to define the economy and military of the future.” While the new U.S. artificial intelligence commission’s report is big on grand industrial policy responses to China, the report did contain many good ideas, such as attracting foreign talent through immigration reforms and improving the technical skills of the domestic workforce. Moreover, the report argued:

The U.S. must work hand-in-hand with allies and partners to promote the use of emerging technologies to strengthen democratic norms and values, coordinate policies and investments to advance global adoption of digital infrastructure and technologies, defend the integrity of international technical standards, cooperate to advance AI innovation, and share practices and resources to defend against malign uses of technology and the influence of authoritarian states in democratic societies.

Many others have been recommending such multilateral responses to China for many years. Robert Atkinson, president of the Information Technology and Innovation Foundation, has proposed a joint U.S.-EU-Japan Technology Alliance or even a “NATO for trade” to craft collective strategies that could counter unfair Chinese policies that harm global free trade and investment. Similarly, a recent Brookings report outlined strategies for “strengthening international cooperation on artificial intelligence” through bodies such as the G-7 and other groups. While multilateral efforts sometimes fail to live up to lofty expectations, they at least offer a more constructive way for a coalition of nations to work together to influence Chinese behavior. For example, unilateral export controls on China aren’t going to do much good if the Chinese can find other vendors or trading partners beyond U.S. shores. A broad-based multilateral alliance of partners, however, might be able to take a more hard-nosed and effective approach to curbing Chinese mercantilism and discouraging other nations from working with them. In the meantime, adopting China’s industrial policy model would be costly and counterproductive. As Washington Post columnist David Ignatius warns, “if officials aren’t careful, government intervention could also afflict our best companies with the dead weight and dysfunction of our broken political system. We need government to spawn brainpower, not bureaucracy.” America needs to embrace its already vibrant venture capital market, the benefits of basic science and prize competitions, and a light-touch regulatory approach instead of gambling taxpayer dollars on grandiose industrial policy schemes that would likely become boondoggles. This article is the fifth in a series on the future of innovation. The first piece in the series is a dialogue between Adam Thierer and Matt Ridley on the proper role of government in promoting innovation. The second article in the series concerns the future of permissionless innovation. The third article examines technological innovation in Europe. The fourth article discusses how India may soon replace China as most innovative place on earth.