This essay is an expanded version of essays first posted on the Law & Liberty website on January 6, 2020, and January 31, 2020.
Arguments about the respective merits of free markets versus economic nationalism go back as far as Adam Smith’s Wealth of Nations (1776) and the defense of a moderate mercantilism essayed by his fellow Scot, Sir James Steuart, in his Inquiry into the Principles of Political Economy (1767). Some of these debates played out in the drama of the American Revolution as the American colonialists turned against the mercantilist economic arrangements of the eighteenth-century British Empire.
In our time, pressures to embrace protectionist policies are intensifying, as are calls for the state to intervene more widely to bolster those occupations, industries, and regions considered net-losers from economic globalization. Governments, according to economic nationalists, should be more actively shaping economic life to realize specific national goals.
Many market liberals have responded by defending economic liberalization’s benefits inside and across borders. But direct critiques of economic nationalism per se are equally necessary. There is good reason to believe that economic nationalist policies will negatively impact the long-term well-being of those nations pursuing them—including America.
What is Economic Nationalism?
Before demonstrating this, however, we require concrete definition of what economic nationalism means. On one level, economic nationalism is associated with protectionism. Policies like tariffs, subsidies and import-quotas seek to protect companies and industries in a given nation from foreign competition. In other instances, economic nationalists have argued that emerging domestic industries require protection from foreign competition until they have become sufficiently stable.
Economic nationalism also expresses itself in the form of industrial policy. In a 2006 World Bank paper, Howard Pack and Kamal Saggi defined industrial policy “as any type of selective intervention or government policy that attempts to alter the sectoral structure of production toward sectors that are expected to offer better prospects for economic growth than would occur in the absence of such intervention, i.e., in the market equilibrium.”
These economic interventions go beyond governments providing basic public works or making the necessary provisions for national defense with which most market liberals from Adam Smith onwards have had little quarrel. Rather, industrial policy involves governments acting selectively to shape a national economy’s structure rather than leaving this to markets operating in a context of the rule of law and private property arrangements.
After 1945, virtually every Western nation embraced industrial policies. The question was one of degree. The specific goals also varied. Sometimes industrial policy sought to correct perceived market failures. In other instances, the aim was to replace particular imports to encourage local production. The objective, however, was not to comprehensively replace entrepreneurship, free prices, market-based allocations of production and investment, or private accumulations of capital. Instead, industrial policy in Western economies involved:
- Nationalizing specific industries (especially utilities and energy companies) considered too important for national well-being to be entrusted to private businesses.
- Targeted government interventions into specific economic sectors through measures like subsidies, preferential tax-treatment, government loans at below-market interest-rates, etc.
The impetus for these policies included desires to accelerate postwar recovery, fast-track economic modernization, and realize certain national security goals. Whatever the political orientation of those implementing these policies in Western countries, they were confident that they could and should do bettwe than the market.
At the same time, these policies went together with a qualified embrace of trade liberalization, first through the General Agreement on Tariffs and Trade (GATT) in 1947 which eventually became the World Trade Organization (WTO) in 1995 that today embraces 166 member nations. In short, from 1947 onwards, most Western countries gradually sought to reduce tariffs, subsidies and import-quotas but also engaged in some degree of industrial policy.
Economic Inefficiency and Political Cronyism
In the late 1970s, trade liberalization accelerated while industrial policy fell into disrepute. Times, however, have changed since market liberalism’s heyday in the 1990s. For the most part, today’s economic nationalists are not proposing to dismantle market economies, let alone embrace state capitalism. Nevertheless, they do believe that nations should rethink, and sometimes reverse, the diminishment of protectionist measures across the world initiated by the GATT in 1947. Others want to expand existing industrial policies and experiment with new policies in this vein.
The attraction of economic nationalist policies is their promise of immediate action to reverse economic decline and promote national greatness. The evidence, however, suggests that such measures, especially when maintained in place indefinitely, have long-term negative effects upon national well-being.
First, economic nationalism makes it harder for individuals, regions, and nations to discover their comparative advantage. Broadly speaking, comparative advantage means that a nation gains by (1) exporting what it has a comparative advantage in producing and (2) importing those things which other countries have a comparative advantage in producing.
This holds even if a country possesses an absolute advantage in every single sector of its economy over another nation. Israel may be able to produce more manufacturing goods and technology than Australia. It is still, however, the case that Israel can obtain more manufactured goods from Australia by specializing in technology and trading some of that output for imported manufactured goods.
Free traders have always recognized that comparative advantage isn’t static. It can be affected by, for instance, political and institutional factors like the degree to which rule of law prevails in a given country.
The very fact, however, that a country’s comparative advantages are constantly changing is, if anything, yet another reason to be wary about experts who think they can second-guess the workings of markets via some combination of industrial policy and tariffs. Such reservations flow from the deep realism about the human condition that is central to critiques of economic nationalism. For one thing, it is simply beyond the ability of any one ostensibly apolitical technocrat or team of experts to absorb all the information that they would need to design the optimal industrial policy for a sector of the economy—let alone an entire national economy. What the Nobel economist F.A. Hayek called “the knowledge problem” is real.
This is not to suggest that individuals and companies who innovate and compete in the marketplace do not often make costly mistakes. This happens all the time. Many businesses fail because they do not pay attention to, or try to insulate themselves from, shifts in comparative advantage. But over the long-term, the superior economic performance of nations that have generally moved in the direction of greater economic liberty and free trade compared to those which have adopted protectionist measures and various industrial policies is hard, as scholars like Douglas A. Irwin have established, to dispute.
That owes a great deal to markets simply being much better at processing and conveying the information needed to make decisions about where to invest, what to buy and sell etc., than government officials. To the extent that economic nationalist policies distort this process of discovery, investment, risk-taking, and enterprise by millions of individuals, businesses and communities which unfold on a daily basis, they cannot help but degrade a nation’s long-term ability to meet its citizens’ economic needs in ever more efficient and effective ways.
Protectionism, however, gradually dulls a nation’s awareness of its comparative advantages. Tariffs, subsidies and import quotas seek to offset foreign competition’s impact on a given industry—and even occasionally succeed. However, one side effect is to discourage that industry from adapting and becoming more efficient under the pressure of foreign competition. The more you protect the industry, the more inflexible and inefficient it will likely become.
Economic nationalists point out that protectionist measures were a major feature of American trade policy until 1947. Some consequently argue that these policies, especially after the American Civil War, played a major role in America’s emergence as an economic superpower between 1776 and 1890.
There is, however, widespread evidence that protectionist policies actually impeded America’s march to economic greatness. Irwin’s detailed analysis of the late 19th-century American economy indicates that economic growth during this period was driven primarily by population growth, capital accumulation and entrepreneurship, rather than the productivity improvements that come from pursuing comparative advantage. Not coincidently, productivity growth was more rapid in those economic sectors “whose performance was not directly related to the tariff.”
Another major study of America’s post-Civil War economy determined that protectionism weakened the gains made by America through technological innovation. The artificially high price of imported capital goods, for instance, made it more difficult and expensive to build America’s transportation and industrial infrastructure. From this perspective, America’s economic success throughout the nineteenth century occurred despite protectionist policies.
Protectionist measures also did considerable damage to the twentieth-century American economy. A prime example is the Smoot-Hawley 1930 Tariff Act. In Peddling Protectionism: Smoot–Hawley and the Great Depression (2011), Irwin demonstrates that increasing tariffs on over 20,000 imports not only resulted in higher prices for American consumers during the Great Depression; it also provoked retaliation against America, thereby hurting those American businesses which produced for foreign markets. As a consequence, Irwin states, “America’s share of world trade fell sharply in the 1930s.”
Then there are protectionism’s negative political repercussions. In his book The Tariff History of the United States (1888), the Harvard economist F.W. Taussig showed how the 1864 and 1867 tariff acts were primarily drafted by those whose businesses were to be protected. The implementation of import duties, Taussig noted, thus had the “chief effect” of putting “money into the pockets of private individuals” with political connections.
A similar picture of rampant cronyism emerges from Irwin’s study of Smoot-Hawley. The Act amounted, he demonstrates, to “a mass of private legislation carried out with little regard for national interest.” Predictably, numerous industries began lobbying for protection as soon as the prospect of tariff increases became politically real. Smoot-Hawley’s drafting was thus characterized by “logrolling, special interest politics, and [an] inability of members of Congress to think beyond their own district.” Ironically, economic nationalism’s protectionist dimension encouraged legislators to put sectional interests first rather than the nation’s well-being.
Warnings from Japan
Similar problems manifest themselves in the realm of industrial policy. Japan’s postwar economic history underscores the point.
Japan’s recovery from World War II was remarkable. The reasons include high rates of domestic private savings that fueled capital and investment accumulation, significant levels of domestic economic freedom, and comparatively low-tax rates. Decisions made by the postwar American occupiers to weaken the power of the Zaibatsu—the industrial and financial conglomerates which dominated Japan’s pre-1939 economy—also made it harder for Japan’s economic establishment to maintain the privileges which had impeded competition in Japan’s economy.
Extensive use of industrial policy is often cited as a major reason for Japan’s postwar success. In addition to selective use of tariffs and subsidies, the Japanese Ministry of International Trade and Industry (MITT) favored particular industries through industrial policies such as attempts at forced mergers and trying to control who owned manufacturing rights. So powerful was MITT and so extensive were its attempts to outguess the market between 1949 and its eventual absorption into Japan’s economics ministry in 2001 that the very phrase “industrial policy” became synonymous with “the Japanese model.”
In the early-1990s, however, Japan’s economy began slipping into what is called the “Lost Decades.” The reasons include an aging population, heavy private sector indebtedness, serious monetary policy errors, and asset bubbles. But industrial policy also played a role. As no less than the Japanese Ministry of Finance’s Policy Research Institute stated in 2002: “The Japanese model was not the source of Japanese competitiveness but the cause of our failure.”
What did they mean by this? First, the proceeds of industrial policy had been heavily tilted to those businesses politically connected to the Liberal Democratic Party that dominated Japanese politics from 1955 until 1993. This undermined efficiency and facilitated widespread cronyism. That in turn created major obstacles to economic reform.
Second, industrial policy in Japan—like everywhere else—involved state officials trying to second-guess the insights and choices of millions of entrepreneurs, investors, businesses, and consumers. For at the heart of industrial policy is the assumption that governments can often better identify which industries are more worthy of investment than others.
But this supposition also runs afoul of the aforementioned knowledge problem. No individual or government ministry can acquire and process all the information needed to determine a nation’s optimal economic structure at any one point in time—let alone in 5, 10 or 20 years in the future.
Worse, government attempts to build up some industries via preferential treatment also undermine the market’s ability to furnish the accurate information needed by entrepreneurs, investors, and businesses to identify the most optimal economic path for each of them to follow—a process which constantly allows millions of piecemeal improvements to the overall economy. By contrast, if industrial policies become a central feature of economic life, inefficiencies will grow throughout the economy as people act on the basis of increasingly bad information. As Japan discovered, that serves no one.
The Seen and Unseen
Economic nationalists also maintain that the nation’s common good requires governments to bolster industries in those sectors and regions that are doing less well than others. We cannot simply allow, the argument goes, whole regions of America to slip into economic decrepitude or entire economic sectors to disappear.
Such decline is regularly attributed to unfair foreign competition. Yet the primary reasons for change are far more likely to be technological change and shifts in comparative advantage. In a concise analysis of American manufacturing, the economist Pierre Lemieux observes that American manufacturing jobs declined from 19 million in 1979 to about 12 million in 2016. Throughout the same period, however, total employment in America grew from 99 million to 151 million, thus dwarfing the loss of manufacturing jobs. Moreover, Lemieux demonstrates that the net manufacturing job decline has been driven by technological innovation and America developing comparative advantage in high-skilled manufacturing.
Contrary to popular myth, America is not deindustrializing. “Physical things continue to be produced,” Lemieux states, “but production occurs more efficiently.” In fact, manufacturing’s contribution to America’s GDP actually increased between 1997 and 2016, while real manufacturing production grew by 180 percent between 1972 and 2007. Now it exceeds pre-Great Recession levels. This is what happens when countries and industries are entrepreneurial, embrace new technology, and adjust to domestic and foreign competitive pressures.
Conversely, tariffs and subsidies will gradually facilitate significant inefficiencies in resource-allocation and widespread distortions of economic information as well as growing cronyism. This is what is occurring in mainland China today. Faltering under the combined weight of an aging population, falling productivity, a dramatic decline in growth, widespread reform-impeding cronyism, and a total debt-level of 300 percent of GDP, China’s own government estimates, as a Foreign Affairs article stated, “that it blew at least $6 trillion on ‘ineffective investment’ between 2009 and 2014 alone.”
Blaming unfair foreign competition also obscures other reasons why particular American industries have declined. Could it be that decades of management complacency and acquiescence with unreasonable union demands have sapped their productivity? Perhaps such businesses were reluctant to adapt to new technologies or chose to invest more energy in playing efficiency-sapping cronyism games. Maybe many American industries have been nudged in particular directions by industrial policies that turned to be less-than-effective than hoped while simultaneously incentivizing less-than-optimal allocations of capital and other resources.
If these causes of decline are real, it is surely counterproductive to use industrial policy and protectionism to rectify the situation. Indeed, it is irresponsible to encourage Americans to enter particular occupations and industries that, absent dramatic reform, will provide fewer opportunities because of declining comparative advantage and technological change? Certainly, policymakers must think harder about how to smooth the social changes that accompany the economic upheavals associated with markets. But instead of using tariffs or import-substitution schemes, wouldn’t it be better to scrutinize all those local, state, and federal ordinances and regulations that dis-incentivize and impede individuals, businesses, localities and regions from adapting?
Then we need to consider economic nationalism’s unseen dimension. This goes beyond American consumers and businesses paying more for goods because of America imposing import tariffs. If the state directs resources to particular businesses, this means those resources are not going to those enterprises which would have received them if markets had been allowed to determine where such resources were allocated.
Take, for instance, the Department of Energy’s $535 million loan-guarantee to the Solyndra enterprise as a result of the Obama Administration’s 2009 American Recovery and Reinvestment Act. The rationale for this failed investment was America’s apparent need to develop solar-energy as a fossil-fuel alternative and the market’s ostensible failure to deliver. Leaving aside the widespread evidence of cronyism driving this particular decision, the broader point is that these resources were effectively diverted away from other businesses because of the perceived necessity to increase America’s solar-energy supply.
Developing fossil-fuel alternatives may or may not be desirable for America. Nevertheless, the Solyndra case illustrates how industrial policy necessarily means selecting some solar-energy companies over many other such businesses—not to mention the thousands of other companies seeking to promote other energy-renewables. Given, however, the sheer amount of ever-changing information needed to be absorbed and processed by state officials if they were to make the optimal investment choice, it’s hard to believe that governments can know which solar-energy companies are more worthy of investment than others or, for that matter, which energy-renewables will be more profitable and sustainable than others.
What about China?
These facts point to a more general challenge: economic nationalist policies are handicapped by the fact that no one can know the future growth businesses in any given nation. No one knows what technological innovation or entrepreneurial insight will upend the present economic landscape in America—or any other country. Nor can such developments be anticipated by economic nationalist policies.
By all means, America should confront authoritarian mercantilist states like China that, among other things, steal intellectual property and routinely violate WTO rules. A concern for free trade, not to mention justice, demands aggressive action in these areas. In the long term, however, economic nationalism damages the common good of those countries which embrace it. That’s the paradox which economic nationalists need to address.
Certainly, America must respond more proactively to China’s particular blend of authoritarian-mercantilism. This presumably means some form of protectionism or selective applications of industrial policy to level a playing field that Beijing is hell-bent on distorting and corrupting as it pursues a distinct geopolitical agenda.
But the United States has numerous tools at its disposal to deal with China’s geopolitical ambitions that don’t involve walking away from a commitment to free trade. These range from diplomatic pressure to bolstering friends in the region, improving its own communications security, pressuring allied governments not to deal with Chinese technology companies like Huawei which will do whatever the Chinese Communist Party tells them to do, rigorously prosecuting Chinese nationals and businesses engaged in espionage and intellectual property theft, and relentlessly highlighting the regime’s brutal repression of religious liberty and its willingness to try and oppress entire ethnic-religious groups like the Muslim Uighurs.
The other point to keep in mind is that free traders from Smith onwards have always paid attention to geopolitical and domestic political realities. In his Wealth of Nations, Smith commented, for instance, that “Not only the prejudices of the public, but what is much more unconquerable, the private interests of many individuals, irresistibly oppose [free trade].” Smith had no illusions on that score. Nor did Smith believe that free trade would lead to eternal peace or that the world would somehow irreversibly embrace free trade. He also accepted the modern nation-state as the basic-building block of international relations and understood that this has implications for trade.
But these facts were not, according to Smith, a reason to shrug our shoulders and succumb to mercantilist temptations. For Smith and others have also long stressed the well-documented damage that a country inflicts upon itself when it adopts such policies in response to similar measures implemented by other nations. The extent to which industrial policy and protectionist policies as a whole are extremely prone to capture by special interests, crony capitalists, and their lobbyist enablers, for example, is one such cost. The evidence here is frankly overwhelming, and the silence of advocates of industrial policy on this point is telling. More generally, economic nationalism amounts to choosing freely to embrace all the inefficiencies and misallocated investments facilitated by tariffs, subsidies, and industrial policies.
It is American consumers, after all, who will pay the costs of tariffs imposed on foreign imports as American companies pass on the higher price of doing business to their customers and/or decide to reduce their American workforces to cover higher import costs. Wealthier and better-educated Americans may be able to absorb the price increases and job losses more easily. But this isn’t so easy for poorer, less-educated Americans. American taxpayers are the ones who will foot the bill for yet another failed industrial policy—not private investors who choose to put their own capital at risk.
Going down the economic nationalist path may provide some political leaders and many Americans with the sense that, finally, something is being done to strike back against countries that implement neo-mercantilist policies. But the cases of Japan and China underscore that such policies store up long-term economic and political problems for the nations which adopt them. If other nations want to pursue economic nationalist policies, there’s only so much we can do to dissuade them. They, however, are paying—or will pay—a significant economic, political and social price for doing so. It is unclear to me why America should wish to emulate their self-inflicted failures.
Economic Nationalism Won’t Make America Great
Part of economic nationalism’s attraction is that it is often presented as a concrete response to many of the social and cultural problems presently characterizing particular regions of America and specific demographic groups. But as Richard Reinsch points out, many economic nationalists have econocentric explanations for challenges such as opioid abuse, family breakdown and intergenerational unemployment.
Yes, there is often an economic dimension to these difficulties. Having a job matters for more than just economic reasons. And yet these dysfunctionalities somehow persist despite the fact that unemployment is presently low across every demographic segment of America’s working population.
This suggests that some non-economic causes must be at work. Consider, for instance, the decline of work among prime-age American males without college degrees. As the economist Nicholas Eberstadt points out in Men Without Work: Post-Pandemic Edition (2022), this decline started in the 1960s—the same time as the Great Society programs began—and it has been rising at a consistent rate since then. He also demonstrates that neither the Great Recession nor China’s entry into the WTO had much impact on American prime-age male inactivity rates. Instead, he suggests, the more relevant reasons are government benefit dependence, changing family structures, and mass incarceration.
These problems cannot be fixed by an industrial policy or a new or expanded tariff. Rather than trying to find industrial policies which will somehow triumph over the reality of the knowledge problem or attempting to discover tariffs that will by some magical means not have major negative effects upon American businesses and consumers, American policymakers and citizens should acknowledge that the benefits promised by economic nationalism are illusory. In the long-term, economic nationalism will not make America great again. On the contrary, it is likely to make the United States a less-economically disciplined, less productive, less adaptable, and less-competitive country. How this would make America great escapes me.
Samuel Gregg is the Friedrich Hayek Chair in Economics and Economic History at the American Institute for Economic Research, and a Contributing Editor at Law & Liberty. The author of 17 books—including The Commercial Society (2006), Wilhelm Röpke’s Political Economy (Edward Elgar), Becoming Europe (2010), Reason, Faith, and the Struggle for Western Civilization (2019), and most recently, The Next American Economy: Nation, State, and Markets in an Uncertain World (2022), as well as over 700 essays, articles, reviews, and opinion-pieces—he writes regularly on political economy, finance, classical liberalism, American conservatism, Western civilization, and natural law theory. Two of his books have been listed for Conservative Book of the Year and one was short-listed for the 2023 Hayek Prize. He is also an Affiliate Scholar at the Acton Institute. In 2024, he was awarded the prestigious Bradley Prize by The Lynde and Harry Bradley Foundation. He can be followed on Twitter @drsamuelgregg
This essay is an expanded version of essays first posted on the Law & Liberty website on January 6, 2020, and January 31, 2020.
Arguments about the respective merits of free markets versus economic nationalism go back as far as Adam Smith’s Wealth of Nations (1776) and the defense of a moderate mercantilism essayed by his fellow Scot, Sir James Steuart, in his Inquiry into the Principles of Political Economy (1767). Some of these debates played out in the drama of the American Revolution as the American colonialists turned against the mercantilist economic arrangements of the eighteenth-century British Empire.
In our time, pressures to embrace protectionist policies are intensifying, as are calls for the state to intervene more widely to bolster those occupations, industries, and regions considered net-losers from economic globalization. Governments, according to economic nationalists, should be more actively shaping economic life to realize specific national goals.
Many market liberals have responded by defending economic liberalization’s benefits inside and across borders. But direct critiques of economic nationalism per se are equally necessary. There is good reason to believe that economic nationalist policies will negatively impact the long-term well-being of those nations pursuing them—including America.
What is Economic Nationalism?
Before demonstrating this, however, we require concrete definition of what economic nationalism means. On one level, economic nationalism is associated with protectionism. Policies like tariffs, subsidies and import-quotas seek to protect companies and industries in a given nation from foreign competition. In other instances, economic nationalists have argued that emerging domestic industries require protection from foreign competition until they have become sufficiently stable.
Economic nationalism also expresses itself in the form of industrial policy. In a 2006 World Bank paper, Howard Pack and Kamal Saggi defined industrial policy “as any type of selective intervention or government policy that attempts to alter the sectoral structure of production toward sectors that are expected to offer better prospects for economic growth than would occur in the absence of such intervention, i.e., in the market equilibrium.”
These economic interventions go beyond governments providing basic public works or making the necessary provisions for national defense with which most market liberals from Adam Smith onwards have had little quarrel. Rather, industrial policy involves governments acting selectively to shape a national economy’s structure rather than leaving this to markets operating in a context of the rule of law and private property arrangements.
After 1945, virtually every Western nation embraced industrial policies. The question was one of degree. The specific goals also varied. Sometimes industrial policy sought to correct perceived market failures. In other instances, the aim was to replace particular imports to encourage local production. The objective, however, was not to comprehensively replace entrepreneurship, free prices, market-based allocations of production and investment, or private accumulations of capital. Instead, industrial policy in Western economies involved:
- Nationalizing specific industries (especially utilities and energy companies) considered too important for national well-being to be entrusted to private businesses.
- Targeted government interventions into specific economic sectors through measures like subsidies, preferential tax-treatment, government loans at below-market interest-rates, etc.
The impetus for these policies included desires to accelerate postwar recovery, fast-track economic modernization, and realize certain national security goals. Whatever the political orientation of those implementing these policies in Western countries, they were confident that they could and should do bettwe than the market.
At the same time, these policies went together with a qualified embrace of trade liberalization, first through the General Agreement on Tariffs and Trade (GATT) in 1947 which eventually became the World Trade Organization (WTO) in 1995 that today embraces 166 member nations. In short, from 1947 onwards, most Western countries gradually sought to reduce tariffs, subsidies and import-quotas but also engaged in some degree of industrial policy.
Economic Inefficiency and Political Cronyism
In the late 1970s, trade liberalization accelerated while industrial policy fell into disrepute. Times, however, have changed since market liberalism’s heyday in the 1990s. For the most part, today’s economic nationalists are not proposing to dismantle market economies, let alone embrace state capitalism. Nevertheless, they do believe that nations should rethink, and sometimes reverse, the diminishment of protectionist measures across the world initiated by the GATT in 1947. Others want to expand existing industrial policies and experiment with new policies in this vein.
The attraction of economic nationalist policies is their promise of immediate action to reverse economic decline and promote national greatness. The evidence, however, suggests that such measures, especially when maintained in place indefinitely, have long-term negative effects upon national well-being.
First, economic nationalism makes it harder for individuals, regions, and nations to discover their comparative advantage. Broadly speaking, comparative advantage means that a nation gains by (1) exporting what it has a comparative advantage in producing and (2) importing those things which other countries have a comparative advantage in producing.
This holds even if a country possesses an absolute advantage in every single sector of its economy over another nation. Israel may be able to produce more manufacturing goods and technology than Australia. It is still, however, the case that Israel can obtain more manufactured goods from Australia by specializing in technology and trading some of that output for imported manufactured goods.
Free traders have always recognized that comparative advantage isn’t static. It can be affected by, for instance, political and institutional factors like the degree to which rule of law prevails in a given country.
The very fact, however, that a country’s comparative advantages are constantly changing is, if anything, yet another reason to be wary about experts who think they can second-guess the workings of markets via some combination of industrial policy and tariffs. Such reservations flow from the deep realism about the human condition that is central to critiques of economic nationalism. For one thing, it is simply beyond the ability of any one ostensibly apolitical technocrat or team of experts to absorb all the information that they would need to design the optimal industrial policy for a sector of the economy—let alone an entire national economy. What the Nobel economist F.A. Hayek called “the knowledge problem” is real.
This is not to suggest that individuals and companies who innovate and compete in the marketplace do not often make costly mistakes. This happens all the time. Many businesses fail because they do not pay attention to, or try to insulate themselves from, shifts in comparative advantage. But over the long-term, the superior economic performance of nations that have generally moved in the direction of greater economic liberty and free trade compared to those which have adopted protectionist measures and various industrial policies is hard, as scholars like Douglas A. Irwin have established, to dispute.
That owes a great deal to markets simply being much better at processing and conveying the information needed to make decisions about where to invest, what to buy and sell etc., than government officials. To the extent that economic nationalist policies distort this process of discovery, investment, risk-taking, and enterprise by millions of individuals, businesses and communities which unfold on a daily basis, they cannot help but degrade a nation’s long-term ability to meet its citizens’ economic needs in ever more efficient and effective ways.
Protectionism, however, gradually dulls a nation’s awareness of its comparative advantages. Tariffs, subsidies and import quotas seek to offset foreign competition’s impact on a given industry—and even occasionally succeed. However, one side effect is to discourage that industry from adapting and becoming more efficient under the pressure of foreign competition. The more you protect the industry, the more inflexible and inefficient it will likely become.
Economic nationalists point out that protectionist measures were a major feature of American trade policy until 1947. Some consequently argue that these policies, especially after the American Civil War, played a major role in America’s emergence as an economic superpower between 1776 and 1890.
There is, however, widespread evidence that protectionist policies actually impeded America’s march to economic greatness. Irwin’s detailed analysis of the late 19th-century American economy indicates that economic growth during this period was driven primarily by population growth, capital accumulation and entrepreneurship, rather than the productivity improvements that come from pursuing comparative advantage. Not coincidently, productivity growth was more rapid in those economic sectors “whose performance was not directly related to the tariff.”
Another major study of America’s post-Civil War economy determined that protectionism weakened the gains made by America through technological innovation. The artificially high price of imported capital goods, for instance, made it more difficult and expensive to build America’s transportation and industrial infrastructure. From this perspective, America’s economic success throughout the nineteenth century occurred despite protectionist policies.
Protectionist measures also did considerable damage to the twentieth-century American economy. A prime example is the Smoot-Hawley 1930 Tariff Act. In Peddling Protectionism: Smoot–Hawley and the Great Depression (2011), Irwin demonstrates that increasing tariffs on over 20,000 imports not only resulted in higher prices for American consumers during the Great Depression; it also provoked retaliation against America, thereby hurting those American businesses which produced for foreign markets. As a consequence, Irwin states, “America’s share of world trade fell sharply in the 1930s.”
Then there are protectionism’s negative political repercussions. In his book The Tariff History of the United States (1888), the Harvard economist F.W. Taussig showed how the 1864 and 1867 tariff acts were primarily drafted by those whose businesses were to be protected. The implementation of import duties, Taussig noted, thus had the “chief effect” of putting “money into the pockets of private individuals” with political connections.
A similar picture of rampant cronyism emerges from Irwin’s study of Smoot-Hawley. The Act amounted, he demonstrates, to “a mass of private legislation carried out with little regard for national interest.” Predictably, numerous industries began lobbying for protection as soon as the prospect of tariff increases became politically real. Smoot-Hawley’s drafting was thus characterized by “logrolling, special interest politics, and [an] inability of members of Congress to think beyond their own district.” Ironically, economic nationalism’s protectionist dimension encouraged legislators to put sectional interests first rather than the nation’s well-being.
Warnings from Japan
Similar problems manifest themselves in the realm of industrial policy. Japan’s postwar economic history underscores the point.
Japan’s recovery from World War II was remarkable. The reasons include high rates of domestic private savings that fueled capital and investment accumulation, significant levels of domestic economic freedom, and comparatively low-tax rates. Decisions made by the postwar American occupiers to weaken the power of the Zaibatsu—the industrial and financial conglomerates which dominated Japan’s pre-1939 economy—also made it harder for Japan’s economic establishment to maintain the privileges which had impeded competition in Japan’s economy.
Extensive use of industrial policy is often cited as a major reason for Japan’s postwar success. In addition to selective use of tariffs and subsidies, the Japanese Ministry of International Trade and Industry (MITT) favored particular industries through industrial policies such as attempts at forced mergers and trying to control who owned manufacturing rights. So powerful was MITT and so extensive were its attempts to outguess the market between 1949 and its eventual absorption into Japan’s economics ministry in 2001 that the very phrase “industrial policy” became synonymous with “the Japanese model.”
In the early-1990s, however, Japan’s economy began slipping into what is called the “Lost Decades.” The reasons include an aging population, heavy private sector indebtedness, serious monetary policy errors, and asset bubbles. But industrial policy also played a role. As no less than the Japanese Ministry of Finance’s Policy Research Institute stated in 2002: “The Japanese model was not the source of Japanese competitiveness but the cause of our failure.”
What did they mean by this? First, the proceeds of industrial policy had been heavily tilted to those businesses politically connected to the Liberal Democratic Party that dominated Japanese politics from 1955 until 1993. This undermined efficiency and facilitated widespread cronyism. That in turn created major obstacles to economic reform.
Second, industrial policy in Japan—like everywhere else—involved state officials trying to second-guess the insights and choices of millions of entrepreneurs, investors, businesses, and consumers. For at the heart of industrial policy is the assumption that governments can often better identify which industries are more worthy of investment than others.
But this supposition also runs afoul of the aforementioned knowledge problem. No individual or government ministry can acquire and process all the information needed to determine a nation’s optimal economic structure at any one point in time—let alone in 5, 10 or 20 years in the future.
Worse, government attempts to build up some industries via preferential treatment also undermine the market’s ability to furnish the accurate information needed by entrepreneurs, investors, and businesses to identify the most optimal economic path for each of them to follow—a process which constantly allows millions of piecemeal improvements to the overall economy. By contrast, if industrial policies become a central feature of economic life, inefficiencies will grow throughout the economy as people act on the basis of increasingly bad information. As Japan discovered, that serves no one.
The Seen and Unseen
Economic nationalists also maintain that the nation’s common good requires governments to bolster industries in those sectors and regions that are doing less well than others. We cannot simply allow, the argument goes, whole regions of America to slip into economic decrepitude or entire economic sectors to disappear.
Such decline is regularly attributed to unfair foreign competition. Yet the primary reasons for change are far more likely to be technological change and shifts in comparative advantage. In a concise analysis of American manufacturing, the economist Pierre Lemieux observes that American manufacturing jobs declined from 19 million in 1979 to about 12 million in 2016. Throughout the same period, however, total employment in America grew from 99 million to 151 million, thus dwarfing the loss of manufacturing jobs. Moreover, Lemieux demonstrates that the net manufacturing job decline has been driven by technological innovation and America developing comparative advantage in high-skilled manufacturing.
Contrary to popular myth, America is not deindustrializing. “Physical things continue to be produced,” Lemieux states, “but production occurs more efficiently.” In fact, manufacturing’s contribution to America’s GDP actually increased between 1997 and 2016, while real manufacturing production grew by 180 percent between 1972 and 2007. Now it exceeds pre-Great Recession levels. This is what happens when countries and industries are entrepreneurial, embrace new technology, and adjust to domestic and foreign competitive pressures.
Conversely, tariffs and subsidies will gradually facilitate significant inefficiencies in resource-allocation and widespread distortions of economic information as well as growing cronyism. This is what is occurring in mainland China today. Faltering under the combined weight of an aging population, falling productivity, a dramatic decline in growth, widespread reform-impeding cronyism, and a total debt-level of 300 percent of GDP, China’s own government estimates, as a Foreign Affairs article stated, “that it blew at least $6 trillion on ‘ineffective investment’ between 2009 and 2014 alone.”
Blaming unfair foreign competition also obscures other reasons why particular American industries have declined. Could it be that decades of management complacency and acquiescence with unreasonable union demands have sapped their productivity? Perhaps such businesses were reluctant to adapt to new technologies or chose to invest more energy in playing efficiency-sapping cronyism games. Maybe many American industries have been nudged in particular directions by industrial policies that turned to be less-than-effective than hoped while simultaneously incentivizing less-than-optimal allocations of capital and other resources.
If these causes of decline are real, it is surely counterproductive to use industrial policy and protectionism to rectify the situation. Indeed, it is irresponsible to encourage Americans to enter particular occupations and industries that, absent dramatic reform, will provide fewer opportunities because of declining comparative advantage and technological change? Certainly, policymakers must think harder about how to smooth the social changes that accompany the economic upheavals associated with markets. But instead of using tariffs or import-substitution schemes, wouldn’t it be better to scrutinize all those local, state, and federal ordinances and regulations that dis-incentivize and impede individuals, businesses, localities and regions from adapting?
Then we need to consider economic nationalism’s unseen dimension. This goes beyond American consumers and businesses paying more for goods because of America imposing import tariffs. If the state directs resources to particular businesses, this means those resources are not going to those enterprises which would have received them if markets had been allowed to determine where such resources were allocated.
Take, for instance, the Department of Energy’s $535 million loan-guarantee to the Solyndra enterprise as a result of the Obama Administration’s 2009 American Recovery and Reinvestment Act. The rationale for this failed investment was America’s apparent need to develop solar-energy as a fossil-fuel alternative and the market’s ostensible failure to deliver. Leaving aside the widespread evidence of cronyism driving this particular decision, the broader point is that these resources were effectively diverted away from other businesses because of the perceived necessity to increase America’s solar-energy supply.
Developing fossil-fuel alternatives may or may not be desirable for America. Nevertheless, the Solyndra case illustrates how industrial policy necessarily means selecting some solar-energy companies over many other such businesses—not to mention the thousands of other companies seeking to promote other energy-renewables. Given, however, the sheer amount of ever-changing information needed to be absorbed and processed by state officials if they were to make the optimal investment choice, it’s hard to believe that governments can know which solar-energy companies are more worthy of investment than others or, for that matter, which energy-renewables will be more profitable and sustainable than others.
What about China?
These facts point to a more general challenge: economic nationalist policies are handicapped by the fact that no one can know the future growth businesses in any given nation. No one knows what technological innovation or entrepreneurial insight will upend the present economic landscape in America—or any other country. Nor can such developments be anticipated by economic nationalist policies.
By all means, America should confront authoritarian mercantilist states like China that, among other things, steal intellectual property and routinely violate WTO rules. A concern for free trade, not to mention justice, demands aggressive action in these areas. In the long term, however, economic nationalism damages the common good of those countries which embrace it. That’s the paradox which economic nationalists need to address.
Certainly, America must respond more proactively to China’s particular blend of authoritarian-mercantilism. This presumably means some form of protectionism or selective applications of industrial policy to level a playing field that Beijing is hell-bent on distorting and corrupting as it pursues a distinct geopolitical agenda.
But the United States has numerous tools at its disposal to deal with China’s geopolitical ambitions that don’t involve walking away from a commitment to free trade. These range from diplomatic pressure to bolstering friends in the region, improving its own communications security, pressuring allied governments not to deal with Chinese technology companies like Huawei which will do whatever the Chinese Communist Party tells them to do, rigorously prosecuting Chinese nationals and businesses engaged in espionage and intellectual property theft, and relentlessly highlighting the regime’s brutal repression of religious liberty and its willingness to try and oppress entire ethnic-religious groups like the Muslim Uighurs.
The other point to keep in mind is that free traders from Smith onwards have always paid attention to geopolitical and domestic political realities. In his Wealth of Nations, Smith commented, for instance, that “Not only the prejudices of the public, but what is much more unconquerable, the private interests of many individuals, irresistibly oppose [free trade].” Smith had no illusions on that score. Nor did Smith believe that free trade would lead to eternal peace or that the world would somehow irreversibly embrace free trade. He also accepted the modern nation-state as the basic-building block of international relations and understood that this has implications for trade.
But these facts were not, according to Smith, a reason to shrug our shoulders and succumb to mercantilist temptations. For Smith and others have also long stressed the well-documented damage that a country inflicts upon itself when it adopts such policies in response to similar measures implemented by other nations. The extent to which industrial policy and protectionist policies as a whole are extremely prone to capture by special interests, crony capitalists, and their lobbyist enablers, for example, is one such cost. The evidence here is frankly overwhelming, and the silence of advocates of industrial policy on this point is telling. More generally, economic nationalism amounts to choosing freely to embrace all the inefficiencies and misallocated investments facilitated by tariffs, subsidies, and industrial policies.
It is American consumers, after all, who will pay the costs of tariffs imposed on foreign imports as American companies pass on the higher price of doing business to their customers and/or decide to reduce their American workforces to cover higher import costs. Wealthier and better-educated Americans may be able to absorb the price increases and job losses more easily. But this isn’t so easy for poorer, less-educated Americans. American taxpayers are the ones who will foot the bill for yet another failed industrial policy—not private investors who choose to put their own capital at risk.
Going down the economic nationalist path may provide some political leaders and many Americans with the sense that, finally, something is being done to strike back against countries that implement neo-mercantilist policies. But the cases of Japan and China underscore that such policies store up long-term economic and political problems for the nations which adopt them. If other nations want to pursue economic nationalist policies, there’s only so much we can do to dissuade them. They, however, are paying—or will pay—a significant economic, political and social price for doing so. It is unclear to me why America should wish to emulate their self-inflicted failures.
Economic Nationalism Won’t Make America Great
Part of economic nationalism’s attraction is that it is often presented as a concrete response to many of the social and cultural problems presently characterizing particular regions of America and specific demographic groups. But as Richard Reinsch points out, many economic nationalists have econocentric explanations for challenges such as opioid abuse, family breakdown and intergenerational unemployment.
Yes, there is often an economic dimension to these difficulties. Having a job matters for more than just economic reasons. And yet these dysfunctionalities somehow persist despite the fact that unemployment is presently low across every demographic segment of America’s working population.
This suggests that some non-economic causes must be at work. Consider, for instance, the decline of work among prime-age American males without college degrees. As the economist Nicholas Eberstadt points out in Men Without Work: Post-Pandemic Edition (2022), this decline started in the 1960s—the same time as the Great Society programs began—and it has been rising at a consistent rate since then. He also demonstrates that neither the Great Recession nor China’s entry into the WTO had much impact on American prime-age male inactivity rates. Instead, he suggests, the more relevant reasons are government benefit dependence, changing family structures, and mass incarceration.
These problems cannot be fixed by an industrial policy or a new or expanded tariff. Rather than trying to find industrial policies which will somehow triumph over the reality of the knowledge problem or attempting to discover tariffs that will by some magical means not have major negative effects upon American businesses and consumers, American policymakers and citizens should acknowledge that the benefits promised by economic nationalism are illusory. In the long-term, economic nationalism will not make America great again. On the contrary, it is likely to make the United States a less-economically disciplined, less productive, less adaptable, and less-competitive country. How this would make America great escapes me.
Samuel Gregg is the Friedrich Hayek Chair in Economics and Economic History at the American Institute for Economic Research, and a Contributing Editor at Law & Liberty. The author of 17 books—including The Commercial Society (2006), Wilhelm Röpke’s Political Economy (Edward Elgar), Becoming Europe (2010), Reason, Faith, and the Struggle for Western Civilization (2019), and most recently, The Next American Economy: Nation, State, and Markets in an Uncertain World (2022), as well as over 700 essays, articles, reviews, and opinion-pieces—he writes regularly on political economy, finance, classical liberalism, American conservatism, Western civilization, and natural law theory. Two of his books have been listed for Conservative Book of the Year and one was short-listed for the 2023 Hayek Prize. He is also an Affiliate Scholar at the Acton Institute. In 2024, he was awarded the prestigious Bradley Prize by The Lynde and Harry Bradley Foundation. He can be followed on Twitter @drsamuelgregg
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