Are Shipyard Subsidies a Good Idea?

By Colin Grabow of Cato.

"In the current National Review cover story, Jerry Hendrix makes the case for restoring the United States to the status of a great seapower. As part of this undertaking Hendrix, a former Navy captain and Director of the Defense Program at the Center for a New American Security, calls for the introduction of subsidies—or more accurately, re-introduction of subsidies—to promote U.S. commercial shipbuilding:

It is important, even critical, to understand that investment in commercial maritime trade is crucial to returning the United States to its historical position as a seapower. Before 1981 the United States government recognized its civilian merchant fleet as a core strategic reserve of maritime power. Commercial ships could carry merchant trade, but they could also carry logistical supplies for the military in wartime. Shipyards could build new ships for civilian fleets as well as the Navy, but they could also repair ships damaged in wartime operations. Shipyards also drove other portions of the economy. For every shipyard blue‐​collar job, five to seven well‐​paying positions were created in upstream parts and component suppliers.

It was a complicated industrial process that was subsidized as a longstanding policy by the federal government, which recognized that a robust and resilient shipbuilding sector was a critical component of a comprehensive national‐​security strategy. These subsidies, however, were ended in the 1980s, and U.S. shipbuilding subsequently withered even as other nations in Europe and Asia continued to subsidize their own shipbuilders. Today China, the world’s largest shipbuilding nation, has over 1,200 shipyards, one of which produces more tonnage per year than the entirety of U.S. shipbuilding. Today China, South Korea, Japan, and Europe control and profit from their participation in a growing and thriving global shipping market while the United States sits largely on the sidelines.

Critics may say that returning to a policy of providing subsidies to our shipbuilding industry would go against free‐​market principles. But we must recognize that every other shipbuilding nation provides such subsidies, to the great benefit of its industries, its economy, and its national security. Returning subsidies to American shipbuilders does nothing more than provide a level global‐​competitive playing field for them and increase the resilience of our overall national‐​security infrastructure. Additionally, any strategy to confront China on the high seas must include a detailed investment and management plan for the nation’s shipbuilding infrastructure so that we can quickly and efficiently rebuild this part of the nation’s economy while strengthening its security. The nation is perhaps fortunate that there is already an acknowledged need to reenergize the civilian shipbuilding base, because most of the nation’s strategic sealift fleet needs to be recapitalized.

Readers may be left with the impression that the United States was among the world’s great shipbuilding countries until its unilateral removal of subsidies that effectively ceded the field to East Asia and Europe. They could also be forgiven for further believing that the restoration of these subsidies would both provide an economic boon and vault the United States back into the ranks of the world’s leading commercial shipbuilders.

Such notions, however, should be greeted with extreme skepticism.

The shipbuilding subsidies that Hendrix refers to were passed as part of the Merchant Marine Act of 1936 and later expanded by the Merchant Marine Act of 1970 before being scrapped by the Reagan administration in 1981. Called construction differential subsidies, they were meant—as the name implies—to cover the difference in cost between building ships in the United States versus less expensive foreign shipyards. Reaching as high as 50 percent of the ship’s price, these subsidies in large part reflected the yawning gap in productivity between U.S. shipyards and their foreign counterparts.

While the subsidies succeeded in channeling billions of dollars into the accounts of U.S. shipbuilders, they did not transform the United States into a major producer of commercial ships as shown by this chart from Tim Colton and LaVar Huntzinger:

As the president of the American Shipbuilders Association testified before Congress in 1996, from the 1950s to the 1970s U.S. shipyards collectively delivered an average of 19 commercial ships per year. While significantly more than the 2–3 built on average currently, such output did not make the United States anything more than a middling commercial shipbuilder. For perspective, a single shipyard in Asia can deliver 50 ships per year.

There is no reason to think that the re‐​introduction of subsidies today would meet with differing results. Indeed, even returning production to 19 commercial ships per year would be an enormously tall order given the lack of shipyards capable of building them. In the United States today, a mere four shipyards are either currently building large commercial ships or have done so in recent years.

It should also be recognized that current anemic production takes place despite the continued subsidization of U.S. commercial shipbuilding. While construction differential subsidies were discarded 40 years ago, the federal government continues to dispense largesse to the sector via its Title XI ship financing program as well as direct grants to shipyards. More importantly, shipyards are also the intended beneficiaries of the Jones Act’s requirement that all vessels used in domestic trade be constructed in a U.S. shipyard. This provision is a massive de facto subsidy to the U.S. shipbuilding industry that is extremely inefficient, counterproductive, and with hidden costs.

Claims that shipyard subsidies can be justified on economic grounds, meanwhile, are questionable at best. Although Hendrix says that shipyard jobs lead to the creation of five to seven well‐​paying positions among upstream parts and component suppliers, no evidence is provided.

Some of the data that does exist suggests a more modest impact. A 2015 report from the U.S. Maritime Administration, for example, calculated that 110,390 jobs are directly provided by the U.S. private shipbuilding and repairing industry with another 289,030 indirect or induced jobs. That’s fewer than 3 indirect or induced jobs for every shipyard position. Even so, the measure of a shipbuilding subsidy’s effectiveness is not jobs but the delivery of actual ships.

With respect to parts and components suppliers delivering a rich vein of employment, it should be kept in mind that the majority of high‐​value components found in U.S.-built ships are sourced from abroad. The last Jones Act ship delivered, for example, the Matsonia, features imported anchors, boilers, cranes, elevators, auxiliary generators, engines, and its propeller. The ship was designed in South Korea by Daewoo Ship Engineering Company—which also served as the ship’s material supplier—while construction of the vessel’s vehicle garage required the use of technology developed by German and Dutch shipbuilders. The ship may have been assembled in the United States, but much of the value-add—and resulting employment—took place elsewhere.

Perhaps most importantly, even if the economic benefits of shipbuilding are considerable, it doesn’t follow that this is where federal dollars should be spent. Money should be devoted not just to a productive end, but to its most productive end. To do otherwise would be to leave the country poorer than would otherwise be the case. Hendrix, however, does not show that shipbuilding subsidies are the most productive end of the money he proposes spending.

But none of this means that his call for subsidies is necessarily wrong.

If it can be shown that the national security benefits of such outlays would outweigh the costs, then they should be firmly on the table. Indeed, there is an opportunity for policy improvement if such subsidies are paired with repeal of the requirement found in the Jones Act and other U.S. coastwise laws (e.g., the Foreign Dredge Act and Passenger Vessel Services Act) that vessels used in domestic commerce be U.S.-built. Swapping explicit and direct subsidies for an opaque and implicit one would not only introduce needed cost transparency but would also surely prove more effective than a domestic build requirement that has utterly failed to produce either a sizable or competitive commercial shipbuilding industry.

The employment of transparent and targeted subsidies coupled with the domestic assembly requirement’s removal would also prove far more equitable than the status quo. Currently, the cost of the Jones Act’s U.S.-built requirement is disproportionately borne by the residents of Alaska, Hawaii, Guam, and Puerto Rico who must use these absurdly and artificially expensive ships for commerce with the U.S. mainland. That’s not fair. If commercial shipbuilding demands subsidies for reasons of national security, then the burden should be spread across all Americans rather than paid for by a relative few based on geographic location.

So should shipbuilding subsidies be adopted? Perhaps. But only with a clear national security rationale, a realistic understanding of what they can accomplish, and reform of the Jones Act’s U.S.-built requirement as part of the deal. Any hope of making the United States a commercial maritime power must include a marked departure from protectionist policies that have failed the industry—and country—so badly."