China’s Economy Is in Worse Shape Than You Think

The estimate of 4.3% GDP growth is below Beijing’s lowest projection—and it’s probably far too high

By Joseph C. Sternberg. Excerpts:

"Beijing’s statisticians on Wednesday said the gross domestic product grew 4.3% year-on-year in inflation-adjusted terms in the April through June quarter. China’s economic data are notoriously prone to fiddling for political purposes. And only this March, the Communist Party set a GDP growth target range of 4.5% to 5% for the year, its most pessimistic since the 1990s."

"Meanwhile there’s accumulating evidence that the country’s true GDP growth rate may be zero, or that the economy is in outright recession. Retail sales were a bright spot in the latest data, increasing 1% year-on-year in June, but looking across recent months this measure of domestic household consumption may be stuck in neutral. Measures of investment are in free fall: Fixed-asset investment has declined 5.7% year-to-date and real-estate investment is down 18%."

"Crude imports in July hit their lowest level in roughly a decade."

"refinery output also is declining"

"demand for energy within China . . . is dropping rapidly."

"it’s hard to find anyone who thinks any of this (more economic “stimulus”) would launch a durable economic recovery. One reason domestic consumption is dipping is that previous iterations of the consumption subsidy (a trade-in scheme, akin to the Obama-era “cash for clunkers” in the U.S., that rewards replacement of old items) pulled forward in time purchases that households would have made anyway, without setting in motion a Keynesian virtuous circle of new corporate investment to meet higher demand. As for public works, China has enough and Beijing’s more important fiscal priority remains bailing out heavily indebted local governments." 

"Domestic consumption is unlikely to revive until the real-estate market has found its bottom." 

Hamilton’s Economic Vision Had One Crucial Blind Spot

Hamilton recognized the importance of manufacturing but overlooked the market processes that create lasting prosperity

By Donald J. Boudreaux. 

"Speaking in January at Davos, US Trade Representative Jamieson Greer said that President Trump’s protectionism revives the policy first proposed by Alexander Hamilton. Like countless attempts to justify US protectionism and industrial policy, Greer’s effort praises Hamilton’s Report on Manufactures (“Report“). 

More recently, Scott Bessent, now holder of a job first held by Hamilton — US Treasury Secretary — also boasted of the administration’s Hamiltonian creed. Given the fame of Hamilton’s Report, and Hamilton’s key role in America’s founding, a close look at his Report is warranted.

Impetus for the Report

Requested by the US House of Representatives in January 1790, Hamilton submitted his Report on December 5, 1791. It was the longest and most famous of four major reports submitted to the House by Secretary Hamilton.

According to Hamilton, the House requested that he devote attention to “the subject of Manufactures; and particularly to the means of promoting such as will tend to render the United States, independent on foreign nations, for military and other essential supplies.” He complied.

America’s Economy Should Have a Strong Manufacturing Sector

The Report opened by making the case that America would benefit from a larger manufacturing sector despite America being unusually rich in land. Without naming Thomas Jefferson, the Report‘s opening was a challenge to Jefferson’s conviction that America should remain a nation mostly of yeomen farmers.

Offering this challenge, Hamilton relied on Adam Smith (also without naming him) to expose the errors of physiocracy — that is, the belief that net economic value is produced only by agriculture. Yet Hamilton went further, arguing that manufacturing can be more productive than agriculture. In making this argument, Hamilton was impressive; one might even sense in it an anticipation of some insights revealed by economists’ marginal revolution of 80 years later.

Regardless of how much or little Hamilton intuited of marginalism, he deserves credit for emphasizing the reality and significance of opportunity costs. To produce some increment of agricultural output requires that some increment of manufacturing output not be produced. And that increment of agricultural output is worthwhile to produce only if its value exceeds that of the foregone manufacturing output. Thus did Hamilton defuse the arguments of persons who believed that, to establish the case for keeping America an agricultural nation, it’s sufficient to point to the positive market value of agricultural output.

In this way, and some others, Hamilton revealed a keen ability to think insightfully about economic matters. Nevertheless, on a full assessment, Hamilton in the Report got more wrong about economics than he got right. Not content to support only the removal of artificial barriers in the US against domestic manufacturing, Hamilton argued strenuously that the government must actively promote American manufacturing. That promotion should consist chiefly of subsidies (“bounties”) supplemented by protective tariffs.

Hamilton Respected But Rejected Adam Smith

The renown of Smith’s Wealth of Nations obliged Hamilton to try to refute Smith’s argument that, in Hamilton’s summary, “industry, if left to itself … without the aid of government will grow up as soon and as fast, as the natural state of things and the interest of the community may require.” For Hamilton, what Smith called “the obvious and simple system of natural liberty” was too simple, at least for a young country without much industry. Here’s Hamilton:

Against the solidity of [Smith’s] hypothesis … cogent reasons may be offered. These have relation to — the strong influence of habit and the spirit of imitation — the fear of want of success in untried enterprises — the intrinsic difficulties incident to first essays towards a competition with those who have previously attained to perfection in the business to be attempted — the bounties premiums and other artificial encouragements, with which foreign nations second the exertions of their own Citizens in the branches, in which they are to be rivalled.

The first-mentioned impediment to American manufacturing was Americans’ alleged lack of entrepreneurship. Habit-bound and excessively risk-averse, too many Americans would stick with familiar agricultural pursuits and refrain from launching new manufacturing endeavors. Further discouraging Americans from venturing into manufacturing were the established competitors abroad who would out-compete upstart rivals. 

For Hamilton, simply being long-established was, in free markets, a nearly insurmountable competitive advantage. But in addition, foreign manufacturers might also practice what we today call “predatory pricing,” as well as enjoy their own subsidies. Therefore, Hamilton believed that manufacturing would arise and thrive in America only if the rates of return on these enterprises were boosted by the government.

Hamilton here forgot his own counsel to attend to opportunity costs. He simply presumed that whatever additional manufacturing activities were encouraged by the government would increase the net value of US economic output. He also ignored both the knowledge problem (How do politicians know which particular industries to encourage?) and the public-choice problem (With subsidies and protection being doled out by politicians, what prevents this doling from being distorted by interest-group politics?).

Hamilton also had a cramped understanding of economic competition. (In fairness, this understanding still infects economics textbooks today.) For him, competition consisted of firms producing a largely given set of outputs with largely identical technologies. Although he can’t be faulted for not reading Joseph Schumpeter’s 1942 work on creative destruction, even in 1791 evidence was growing that the major source of economic growth was entrepreneur-driven creative destruction. Such innovation introduced not only new products, but also completely new and improved means of producing existing products. 

In such an innovative economy, being long-established wasn’t the great advantage that Hamilton assumed it to be. Just ask, for example, the American millers whose traditional manner of milling flour was rendered obsolete starting in the 1780s in Delaware by Oliver Evans‘s automated flour mill.

Hamilton’s Curious Evidence

Attempting to augment his case for active government encouragement of manufacturing, Hamilton offered curious evidence. Responding to opponents who insisted that America’s economy was unfit for manufacturing, he boasted that America’s economy was already demonstrating an impressive ability to support manufacturing.

Writing about the prospects of profitable investment in manufacturing, Hamilton said that “it is certain that the United States offer a vast field for the advantageous employment of capital; but it does not follow, that there will not be found, in one way or another, a sufficient fund for the successful prosecution of any species of industry which is likely to prove truly beneficial.” He continued: In addition to America’s “multiplying” banks, another ready source of funding for manufacturing was foreign capital, which he wisely welcomed as “a precious acquisition.” Indeed, “the attraction of foreign Capital for the direct purpose of Manufactures ought not to be deemed a chimerical expectation. There are already examples of it.”

Question for Hamilton: If it was certain that the US offered vast opportunities for profitable investments in manufacturing, and if such investment was already occurring, why did such investment need to be further stimulated by the government? Hamilton’s inconsistency is evident.

Another example of Hamilton’s inconsistency is worth mentioning. When he argued for subsidies and protective tariffs for goods produced with iron, his evidence for the worth of such government assistance was the fact that such manufacturing had significantly grown in the US since the American Revolution and was flourishing. His argument was that this industry deserved protection precisely because it had proven itself capable and successful. Presumably, Hamilton would defend this inconsistency by maintaining that, without government assistance, this industrial growth — and that of other critical manufacturers — would stop short of its optimal point.

Here’s where Hamilton-as-economist faltered most seriously. He made the incorrect presumption that markets fail to generate optimal economic growth because, in the end, he didn’t appreciate just how effectively resources are allocated by market signals and incentives — by competitively determined prices, profits, and losses. 

At least for fledgling nations with relatively little industrial capacity, he believed that intervention from the top was required.

The Lasting Lesson

Studying the Report on Manufactures makes clear that Hamilton, contrary to the assertions of Greer and Bessent, was far from being a protectionist in the mold of Donald Trump. 

Not only was Hamilton’s case for protection confined to the need to stimulate industrial capacity in a country lacking such capacity, he also preferred subsidies over tariffs (because tariffs, unlike subsidies, reduce supplies of targeted goods), and he welcomed, rather than bemoaned, net inflows of foreign capital. 

Nevertheless, Hamilton ultimately had too little confidence in free markets. The late Gordon Wood’s assessment of Hamilton-as-economist is accurate:

Hamilton was so wedded to a hierarchical view of society that he could only imagine industrial investment and development coming from the top down. Thus he was incapable of foreseeing that the actual source of America’s manufacturing would come from below, from the ambitions, productivity, and investments of thousands upon thousands of middling artisans and craftsmen who eventually became America’s businessmen. Hamilton’s historical reputation as the prophet of America’s industrial greatness therefore seems somewhat exaggerated. He certainly wanted a powerful and glorious nation, but he was no more capable of accurately foretelling the future than the other American leaders."

Chuck Schumer’s Chip Shortage

A Micron plant in New York is years behind schedule for all the reasons you’d expect

WSJ editorial. Excerpt:

"Consider Micron’s massive fabricator project in upstate New York, which it announced in October 2022. “With the CHIPS and Science bill I wrote and championed as the fuse, Micron’s $100 billion investment in Upstate New York will fundamentally transform the region into a global hub for manufacturing,” New York Sen. Chuck Schumer boasted."

"The 2022 Chips Act provided some $53 billion, plus a 25% investment tax credit, to subsidize U.S. chip-making."

"Congress in 2024 passed a law exempting some semiconductor projects from the National Environmental Policy Act’s stringent environmental reviews. But the exemptions don’t apply to Micron’s project."

"it includes hundreds of acres of wetlands and forestland that are nesting areas for endangered bats. This makes permitting and building more complicated. Trees can only be chopped down when bats aren’t nesting—i.e., from November to March."

"Construction was supposed to start two years ago, but tree clearing didn’t begin until this past January"

"environmental impact statement numbered more than 700 pages" 

Industrial Policies

By Jeffrey Miron and Emily Bronckers.

"Industrial policy — government effort to favor certain sectors, technologies, or firms — has a long history. Far from a fringe idea, politicians across the spectrum have promoted such policies for centuries. But the results are far more problematic than its current popularity suggests.

The pattern appeared early. Federal land grants built the transcontinental railroad and delivered real economic development — alongside spectacular corruption, fraud, and overbuilding. That combination has recurred often. Republican administrations have imposed tariffs and subsidized fossil fuels; Trump’s 2018 steel tariffs protected a narrow producer class while raising costs across industries that use steel, on net destroying jobs. Democratic administrations built the Tennessee Valley Authority — which brought electricity to rural Appalachia but became a major coal-burning polluter — and invested in green energy under Obama, producing high-profile failures like Solyndra alongside modest successes at considerable taxpayer cost. Biden’s CHIPS Act commits hundreds of billions to semiconductors; it is too soon for a full verdict, but early reports show significant cost overruns.

Proponents point to South Korea, Japan, and Taiwan as proof that industrial policy can work. But for every South Korea there is a Brazil or India, where decades of protection have produced inefficiency rather than competitive industries. Some economists question the Korean case even more directly: the industries the government subsidized were not the ones most correlated with growth, suggesting the policy may have been targeting the wrong sectors. Economists also debate how much credit belongs to government direction versus stable macroeconomics, high savings rates, and openness to foreign technology.

It helps to place industrial policies on a spectrum, with targeted subsidies and trade protection at one end, and fully planned economies at the other. The Soviet Union and Maoist China were the paradigmatic examples, and their failures were catastrophic — chronic shortages, misallocation, and collapse. Defenders of modern industrial policy argue that targeted interventions are different from central planning, and formally that is true. But the underlying problem — that officials lack the information markets generate and face political pressures that distort allocation — does not disappear because the intervention is more modest."

The Road to AI State Socialism

Bernie Sanders sees Trump industrial policy and decides to raise the government stakes

WSJ editorial. Excerpts:

"Mr. Sanders wants to force companies to hand over half of their equity to the government."

"this would be a government expropriation. It would violate the Fifth Amendment’s prohibition on government taking property without just compensation. To pay this tax, companies would have to issue new shares to the government diluting current shareholders. Or they could buy back half their shares from private investors and hand them to the government."

"One model is China’s state-owned enterprises, which are an albatross on its economy. Political favoritism and government interventions have led to economic inefficiencies. Hence China’s partially state-owned Semiconductor Manufacturing International trails TSMC and Samsung in chip fabrication." 

The Washington consensus works: Causal effects of reform, 1970-2015

By Kevin B. Grier & Robin M. Grier. From Journal of Comparative Economics.

"Abstract

Traditional policy reforms of the type embodied in the Washington Consensus have been out of academic fashion for decades. However, we are not aware of a paper that convincingly rejects the efficacy of these reforms. In this paper, we define generalized reform as a discrete, sustained jump in an index of economic freedom, whose components map well onto the points of the old consensus. We identify 49 cases of generalized reform in our dataset that spans 141 countries from 1970 to 2015. The average treatment effect associated with these reforms is positive, sizeable, and significant over 5- and 10- year windows. The result is robust to different thresholds for defining reform and different estimation methods. We argue that the policy reform baby was prematurely thrown out with the neoliberal bathwater." 

Highlights

         Sustained economic reform significantly raises real GDP per capita over a 5- to 10-year horizon.

         Countries that had sustained reform were 16% richer 10 years later.  

        Despite the unpopularity of the Washington Consensus, its policies reliably raise average incomes."

Also see What is the “Washington Consensus?” by Douglas A. Irwin and Oliver Ward. Excerpt:

"The main Washington Consensus policies include maintaining fiscal discipline, reordering public spending priorities (from subsidies to health and education expenditures), reforming tax policy, allowing the market to determine interest rates, maintaining a competitive exchange rate, liberalizing trade, permitting inward foreign investment, privatizing state enterprises, deregulating barriers to entry and exit, and securing property rights."

Liberalising reforms have more often than not delivered medium-term growth improvements

See Big reforms, big returns? Evidence from structural reform shocks by Alessio Terzi & Marco Pasquale Marrazzo. From the journal Economic Modelling.

"Abstract

Following a series of disappointing outcomes in Latin America and Sub-Saharan Africa, traditional structural reform shocks, of the type advocated under the ‘Washington Consensus’, came to be widely viewed as unsuccessful. This paper revisits that conclusion by applying a novel generalised use of the non-parametric Synthetic Control Method with multiple treated units to estimate the impact of 23 policy reform shocks (spanning both real and financial sector measures) implemented globally between 1961 and 2000. Our results suggest that, notwithstanding a muted short-term impact, wide-reaching reforms on average raised GDP per capita by around 6 percentage points over a decade. These findings are robust across alternative specifications, placebo and falsification tests, and different reform indicators. While outcomes were heterogeneous, the results indicate that broad liberalising reforms have more often than not delivered medium-term growth improvements, underscoring the importance of understanding the conditions under which they succeed." 

Also see What is the “Washington Consensus?” by Douglas A. Irwin and Oliver Ward. Excerpt:

"The main Washington Consensus policies include maintaining fiscal discipline, reordering public spending priorities (from subsidies to health and education expenditures), reforming tax policy, allowing the market to determine interest rates, maintaining a competitive exchange rate, liberalizing trade, permitting inward foreign investment, privatizing state enterprises, deregulating barriers to entry and exit, and securing property rights."

Beijing’s Big Problem: An Incredible Shrinking Economy

By Jon Emont of The WSJ. Excerpts:

"In dollar terms, China’s gross domestic product, as a share of the global economy, peaked in 2021 at around 18.5%, when it grew to be around three quarters of the size of the U.S. economy."

"Instead China’s share of the pie has decreased, ending 2025 at around 16.5% of the global economy. It is now less than two-thirds the size of the U.S. economy"

The problem is "deflation, which reduces the value of goods in the economy, and a weak yuan has zapped the relative size of China’s economy as measured in dollar terms. So even though China’s economy has been producing more goods than ever, the dollar value of what it makes has been stagnant" 

"Another method, purchasing power parity, shows how much Chinese can purchase at home. According to this yardstick, China’s economy now far exceeds the U.S."

"A different measure is to compare economies using dollars from a fixed point in time, thus eliminating the effects of inflation. By that gauge, China is growing consistently.

But economists often compare the size of economies using present-day dollars because the greenback is the currency of international trade and a measure of actual buying power globally. That makes China’s shrinking share of the global economy worrying for global businesses, whose investments in China bring home less in dollar terms now."

"China’s challenged economic situation echoes the economic trajectory of Japan, which grew to be nearly three-quarters of the U.S. economy in 1995, but has since fallen to less than 15% of the U.S., as a weak yen and deflation eroded the country’s buying power."

Every President Tries It. It Never Works. (to increase manufacturing jobs)

By Jason Furman. Excerpts:

"In a full accounting, during the first full month of his second term, the United States lost 2,000 manufacturing jobs. Losses continued almost every month, totaling 100,000 manufacturing jobs since January 2025."

"In his 2024 State of the Union address, President Joe Biden declared, “We’ve got 800,000 new manufacturing jobs in America and counting.” The next morning the Bureau of Labor Statistics announced that the economy had lost 4,000 manufacturing jobs the previous month. More losses followed, in almost every subsequent month of Mr. Biden’s presidency, totaling 202,000 in his last year. The 800,000 new jobs he exulted in were not the beginning of a sustained recovery of manufacturing but rather the return of some of the 1.4 million positions lost during the Covid pandemic."

"Reversing the loss of manufacturing jobs is extremely hard — and not necessarily desirable."

"Manufacturing job share has been dwindling in nearly all middle- and high-income countries. By one analysis, China lost more than 30 million of those jobs from 2011 to 2020, more than twice as many as the number of jobs that exist in the entire U.S. manufacturing sector. Yet total employment continued to grow"

"Manufacturing output, meanwhile, has risen, because workers now produce far more per hour using better and more sophisticated equipment. Today a given number of autoworkers can make, according to my calculations, three times as many cars in a year as they could 50 years ago.

The problem is that consumers do not want three times as many cars. Even as people get richer, they increase their spending on manufactured goods only modestly, preferring instead to spend more on services like travel, health care and dining out. There are only so many cars a family can own, but that’s not the case for expensive vacations or fancy meals. As a result we have fewer people working in auto factories and more people working in luxury resorts and the like.

These forces — rising productivity but steady demand — explain why the United States was losing manufacturing job share as far back as the 1950s and 1960s, long before trade became a major factor. The downward trend changed little after the U.S. entered NAFTA in 1994 or granted permanent normal trade relations to China in 2000. Economists continue to debate the magnitude of the “China shock,” but though it hit some regions harder than others, much of the research suggests that overall, it was responsible for a small fraction of the total manufacturing jobs lost since then."

 

"When governments try to reverse the trend, they mostly succeed only in shifting jobs from one industry to another rather than expanding manufacturing overall. Tariffs on steel, for example, may protect jobs in steel production, but they cost jobs in downstream industries such as automobiles by raising costs and undermining global competitiveness.

Subsidies for targeted industries — Mr. Biden’s preferred approach, particularly for microchips and green energy — have similar trade-offs. They help the favored industries but they also drive up construction and equipment costs across the board, making it harder for companies in other arenas to compete. So instead of creating more jobs overall, the subsidized industries just crowd out unsubsidized ones.

Efforts to revive manufacturing are rooted in nostalgia. Once upon a time, manufacturing jobs provided a reliable pathway to the middle class, offering a wage premium to workers without a college degree. In 1970, roughly 80 percent of manufacturing workers had no more than a high school education. Today that figure is closer to 40 percent.

Manufacturing jobs also used to pay more than nonmanufacturing jobs with similar skill requirements. Not anymore: Today people in nonmanagerial manufacturing jobs average $30 an hour as compared with $32 for truck drivers, $33 for wholesale trade workers and $38 for construction workers. Trying to push more people into manufacturing jobs is therefore more likely to harm the middle class than help it."

Related post:

The manufacturing delusion? (2023) This has an article by Christina Romer that makes points similar to Furman's

The Credit Engine Behind China’s Economy Is Sputtering

Cheap lending to low-quality borrowers renders one of Beijing’s prime policy tools less efficient.

By Joseph C. Sternberg. Excerpts:

"Beijing itself doesn’t believe the economy is improving. Officials this month promulgated a series of economic plans centered on a GDP growth target of 4.5% to 5%, the lowest since 1991. In part that target sends a signal from the senior Communist Party leadership to other officials that Beijing will tolerate some of the pain of an economic adjustment. Local cadres shouldn’t rush to juice the stats with excessive lending and white-elephant public-works projects."

"It’s widely understood that the government economic data concerning GDP growth are a lie intended to flatter the party."

"Since Mr. Xi embarked on the property correction in August 2020, Beijing has tried to steer the economic rebalancing carefully—sometimes allowing fate to run its course by bankrupting some companies or stressing some local governments overexposed to off-balance-sheet real-estate lending, other times arresting the decline with old-style policy hacks such as credit subsidies."

"Evidence is accumulating that Beijing’s firepower is running down"

"the total rate of credit growth is slowing dramatically: to 6.1% year-on-year in January, compared with an average of 9% a year in 2017-24 and 18.1% in 2007-16."

"Some 58% of loans in December were made at interest rates at or below the official benchmark lending rate of 3%"

"that proportion has risen steadily over the past couple years"

"This suggests banks are struggling to find borrowers (read: in the private sector) that could generate returns above 3%, which is remarkable in a developing economy with enormous potential for catch-up growth"

"banks are lending to inefficient state-owned enterprises and investment pools linked to local governments. Cheap lending to low-quality borrowers then weighs on bank profits, hindering future productive lending" 

State promotion of small-holder agriculture; state promotion of manufacturing; and state controls over finance, especially capital controls DID NOT cause rapid growth in four African countries

See ‘How Africa Works’ Review: Policies and Prosperity; Four African countries—Botswana, Ethiopia, Mauritius and Rwanda—experienced rapid per capita growth. How did they manage it? William Easterly reviewed the book How Africa Works: Success and Failure on the World's Last Developmental Frontier by Joe Studwell. Excerpts:

"the successful countries were, surprisingly, not very good at following his preferred policies. Botswana’s government promoted neither small-holder agriculture nor manufacturing. Mauritius and Rwanda ended capital controls long ago. Mauritius also successfully promoted manufacturing until it did not, and the share of manufacturing in the economy fell to 11% in 2020 from 20% in the 1980s. The author gives Rwanda a tepid grade on the three policy approaches."

"Ethiopia’s government promoted manufacturing with some successes in cement and floriculture, but its leading state enterprise asked North Korea for help to build 10 sugar mills as part of a vast sugar-development project. (It did not end well.)"

"As for the nonsuccesses, Mr. Studwell notes that some of the three policies were followed there, too. Promoting manufacturing has been a popular idea throughout Africa for decades. Ghana’s enthusiasm for manufacturing contributed to the long decline of its economy, from independence in 1957 to the 1980s. As the author notes, the country encouraged the assembly of automobiles, from kits of car parts, when the value of a finished car was sometimes less than the cost of the parts kit. The author worries that Ghana is repeating this automobile nonsuccess today."

"Nigeria’s Ajaokuta steel plant, which cost billions of dollars but never got around to producing any steel."

"Capital controls were also popular among the nonsuccesses. The author notes how the International Monetary Fund insisted on removing capital controls in the majority of African countries in the 1990s, an indication that the restrictions were widespread at the time. He does not note that these capital controls often went to extremes. When inflation is high, controlled interest rates are far lower than inflation, and capital controls are fierce: Savers can’t preserve their wealth by moving it to dollar-denominated assets outside of the country. Some called such a package financial repression and suggested that savers move their wealth out of banks and into real estate or other real assets (or do not save at all). If savers don’t deposit any money in domestic banks, then the banks will have no money to lend, and borrowers will not get the subsidized bank loans Mr. Studwell favors. Destroying both savings and credit does not seem like a win." 

STATE CAPACITY AND ECONOMIC GROWTH: CAUTIONARY TALES FROM HISTORY

By Sheilagh Ogilvie.

"Abstract 

This paper uses economic history to probe the relationship between state capacity and economic growth during the Great and Little Divergences (c.1500–c.1850). It identifies flaws in the dominant measure of state capacity, fiscal capacity, and advocates instead analysing state expenditures. It investigates five key activities on which states historically spent resources: waging war; providing law and administration; building infrastructure; pursuing industrial policy; and fostering a national culture. The lesson of history, it concludes, is not to build a capacious state. Rather, we need a state that uses its capacity to help (or at least not hinder) market activity."

The image below has an excerpt that was posted on Twitter by Douglas Irwin: 

 

Irwin also says "See also @antonhowes excellent discussion of Tudor industrial policy & trade wars....

Age of Invention: Tudor Trade War The true effects of Henry VII's "industrial policy" 

"Bizarrely, Henry VII’s control of export licences and trade bans are often described as a case of early home-biased industrial policy — an idea most recently popularised by the bestselling economics author Ha-Joon Chang.17 Henry’s policies have been presented as a purposeful stimulus to England’s export of cloth, allowing English industry to rise up through protectionism before it later “kicked away the ladder” for other countries by imposing trade rules free of tariffs and import bans. But Chang based his information almost entirely on a 1720s writer, Daniel Defoe, who was seeking precedents to justify protectionism in his own time, and who got some crucial details utterly garbled."

"The reality then was that Henry’s trade ban did more to hinder the English economy than help it — which is also very clearly borne out by the data on cloth exports. It was only when he stopped declaring on-and-off trade bans with the Low Countries that England’s cloth exports finally gained a secure basis for growth. With trade allowed to grow for the next fifty years, this time with relatively few further interruptions, the weight of English cloth exports more than doubled, and increased by even more in terms of value. It was not by imposing embargoes, but by refraining from them, that England’s main manufacturing industry finally had the chance to expand."

China’s Sprint for Tech Dominance Can’t Hide an Economy Full of Holes

Self-sufficiency push has made China a tougher competitor to the U.S., but it comes with enormous waste

By Brian Spegele of The WSJ. Excerpts: 

"Factory robots run by artificial intelligence churn out products that jobless college graduates cannot afford. State technology funds throw billions of dollars at money-losing startups even as the national debt surges to unprecedented levels."

"Beijing’s gains are coming at a steep cost, with the state’s heavy-handedness in directing investments wasting colossal amounts of money. The hundreds of billions of dollars China spends each year on domestic technology also eats away at the money for rural education, reinforcing the social safety net and other programs economists say are needed to put growth on a firmer footing."

"Of the 129 brands selling electric cars and plug-in hybrids in China as of last year, only 15 are expected to be financially viable by 2030"

"Home prices are down 17% since the pandemic"

"Per capita disposable income in cities is less than $700 a month, while in the countryside as many as several hundred million people subsist on just a few dollars each day."

"In Mianchi County . . . spending on science and technology rose nearly 50%, even as government revenue fell more than 10%."

"Yet some government workers aren’t getting paid."

"Government debts across China are estimated to have roughly doubled between 2019 and 2024, hitting as much as $23 trillion"

"productivity growth is slowing"

"state aid, such as cash subsidies, tax breaks and cheap credit to businesses, has reduced China’s overall GDP by as much as 2%, and cost around $800 billion in 2023"

"Throttling back state support for companies would allow the market to play a bigger role in more efficiently directing China’s money to where it is needed, she said." [IMF Managing Director Kristalina Georgieva]

"Provincial officials poured tens of billions of dollars into government-favored sectors. Much of it has gone to waste"

"tech investments and state subsidies are flowing to sectors that aren’t creating nearly enough jobs. One out of six young people in Chinese cities is out of work." 

There Is No Such Thing as Good Industrial Policy. But Republicans And Democrats Keep Trying.

Real industrial policy has been tried—in many countries, by governments of every ideology. It fails every time for the same reason.

By Veronique de Rugy. 

"American industry has been getting a lot of hands-on direction from Democrats and Republicans for quite some time now. Every few years, someone looks at the underwhelming results of this economic maneuvering and insists that real "industrial policy" has never been tried. The truth is that the left's call for a "mission-oriented" state and the right's yearning for a nationalist industrial revival may sound different, but they share the same conceit: that their own intentions can finally succeed where decades of intervention have failed.

The latest person to revive this evergreen fantasy is Mariana Mazzucato, the Italian-born economist who has made a career out of championing an assertive, big-spending state as the engine of innovation. In a new interview with Politico, she laments that President Donald Trump's industrial policy—which includes tariffs and government equity stakes in private companies—is "an idiosyncratic hodgepodge," not the "holistic" strategy she favors. Mazzucato wants the U.S. to have a "smart, capable" state to guide investment with purpose.

Back in the days of former President Joe Biden's industrial policy, when subsidies, tax credits, and loans were flowing, an emerging Republican faction had a similar refrain, claiming that to revive American manufacturing, restore communities, and put men back to work, industrial policy simply had to be done right. We now know that this meant increasingly erratic tariffs, price controls, and government taking shares in companies.

Hope for both sides rests on quite a premise: that Washington can guide trillions of dollars to the right industries, produce a manufacturing boom, and maybe even heal America's social fabric.

The problem isn't that industrial policy has been done badly. It's just bad economics.

Dreams of reviving manufacturing jobs face the reality that modern manufacturing is capital-intensive and largely automated. Even if subsidies or government loan guarantees spur a factory boom—and history suggests otherwise—it won't bring back 1950s-style armies of industrial workers unless we somehow outlaw productivity. Today's factories run on robots and engineers.

Nor will tariffs bring a manufacturing revival. Taxing inputs and components only raises costs, weakens U.S. competitiveness, and ultimately punishes the firms protectionists claim to support. True American industrial strength rests on productivity, innovation, competition, and access to global supply chains, not on coddling producers behind walls of higher prices.

Mazzucato and her ideological opposites commit the same error. They imagine a politics-free technocracy that can "direct" the economy. In the real world, politics always dominates economics. Subsidies and tariffs are never tools of neutral expertise; they are invitations to lobby. Every "strategic investment" quickly becomes a political IOU.

Biden's programs came loaded with child care mandates, union preferences, and "Buy American" rules. Trump's industrial interventions are indeed erratic, but the notion that his protectionism would work if wrapped in a more "mission-oriented" narrative is even sillier. Industrial policy doesn't fail because it's chaotic; it fails because it's political, and human politicians are incapable of the precision markets achieve every day.

After conducting a sweeping review of five decades of U.S. industrial policy, economists Gary Clyde Hufbauer and Euijin Jung's conclusion was unambiguous: Subsidies and trade protections for individual firms have been politically irresistible but economically ruinous. Government protection delays economic adjustments; innovation succeeds. In the rare cases when industrial policy showed positive results, the government limited itself to supporting open, competitive research and innovation—programs like the Defense Advanced Research Projects Agency or Operation Warp Speed—rather than shielding firms from competition or subsidizing failing industries.

Without that type of openness, supposed industrial policy wins will quietly lock in yesterday's technology rather than helping discover tomorrow's. France's Minitel, a government-backed precursor to the internet, looked like a national triumph in the 1980s. Millions of households were connected, citizens used it for banking, shopping and communicating, and the state could boast of digital leadership. Yet the system's centralized, permission-based design smothered innovation and prevented France from developing the open, global internet that would soon transform the world.

The illusion of progress turned out to be technological stagnation: a product that barely evolved over three decades. This is the unseen cost of industrial policy. By insulating favored industries and technologies, it freezes innovation in place and leaves a nation paying twice: once through taxes and again through missed opportunities.

So yes, real industrial policy has been tried—in many countries, by governments of every ideology, under every rhetorical banner from "innovation" to "resilience." It fails every time for the same reason: The visible hand of the government is clumsy, self-interested and easily bought. If that's what passes for a "smart state," I'll take the invisible hand of the market any day."

The space race failed to boost the wider economy

See Technological spillovers: Shawn Kantor and Alexander Whalley discuss the long-term effects of public R&D investment made during the Cold War–era space race by Tyler Smith of the AEA. 

"The launch of Sputnik by the Soviet Union in October 1957 led to a geopolitical crisis that reshaped American science policy. Within months, Congress established NASA, and by 1961, President Kennedy committed the nation to landing a man on the moon before the decade's end. The resulting investment was massive, and the program still serves as a model of government spending for advocates of public R&D. 

In a paper in the American Economic Review, authors Shawn Kantor and Alexander Whalley question whether the space race program succeeded as an economic policy that boosted economic growth and productivity.

To estimate the space program's effects on economic growth from 1947 to 1992, the authors used data on NASA contractor spending and a novel identification strategy based on declassified CIA documents that allowed them to determine which US industries in which counties specialized in space-relevant technologies before the space race began. Their findings complicate the conventional narrative about public R&D and provide important context for current proposals to replicate so-called “moonshot” models in other domains.

Kantor and Whalley recently spoke with Tyler Smith about the local effects of space race spending and why they didn’t translate into long-term productivity gains.

The edited highlights of that conversation are below, and the full interview can be heard using the podcast player.

Tyler Smith: In this paper, you're studying the knock-on effects of the Cold War–era space race program. Why did you want to explore this period of history?

Shawn Kantor: The space race is an iconic moment, so politicians and economists often use it. They think about that particular era as a time when public investment in R&D had amazing growth potential, stimulated economic activity, and led to all these great spillover effects that presumably we should be able to measure and know about. So, in terms of our overall research, we figured the space race seemed to be a nice place to look. Nobody's looked at it. Just measuring the returns to R&D seemed to be a vexing problem that economists are still facing. So we thought we would just take a stab at it.

Smith: How did you all figure out whether NASA spending actually caused economic growth versus just going to places where there was already capacity for growth?

Alexander Whalley: One of the concerns is that NASA could harvest effective technologies that are already in the United States and utilize those. The moon mission and R&D spending is not random. NASA was trying to win the race. They're looking for where they're going to have the biggest impact. We really tried to go back and measure which areas of the United States already had some kind of comparative advantage in space technology. It was challenging because there really wasn't space technology in 1958. How do you think about what that actually is? We used these historical files of the research the CIA was doing on Soviet space technologies. We used that to define what space technology was, the kind of things the Soviets were actually doing. We looked at that in the patent record in the United States and tried to figure out which areas and which locations were doing space technology before this started. That was really the essence of our research design.

Smith: Can you elaborate on that a little bit? Why would Soviet space technology help you estimate the impact of NASA spending?

Kantor: In terms of doing the causal identification, the nice feature of the paper is that it's looking at post-Sputnik Soviet technology as researched by the CIA. So we got the declassified CIA documents regarding Soviet space technology past 1958. And then we used that information to try to understand which American companies were doing that sort of work before Sputnik. And so we didn't want to use what NASA was doing because that could be correlated with NASA's harvesting of technologies, putting money where there was already potentially some opportunities in the American economy. We didn't want that. What we wanted is a situation where we had a true picture of what the demands were for getting into space and then looking at who was doing that research before Sputnik.

Smith: Once you had this estimation strategy in place, what did you find happened when NASA spending started flowing into large urban counties with space-related industries? What happened to the local economy?

Kantor: Not surprisingly, the companies that were getting this largesse grew substantially, like on the order of 35 to 50 percent in terms of employment and value added capital stock. They're just expanding rapidly relative to other counties and industries that didn't have that technology in place. So the companies that you would expect to be the beneficiaries of NASA spending were certainly expanding. But the critical thing that we found was that those benefits that accrued to those counties and space industries didn't spill over to other industries in the same county or to neighboring counties. So it was really heavily localized to those beneficiaries.

Smith: You calculate something called a fiscal multiplier. What is the fiscal multiplier in the context of your study and how big was it?

Whalley: We have this increase in output. Firms are getting bigger; they're hiring more workers. But how big is that effect and what would you compare it to? One thing that's really nice is that there are lots of estimates in the economic literature about different government spending programs. We have lots of estimates of how big the bang for the buck is there. Basically if you spend a dollar on an industry and location, how much does output increase? Does it increase by more than a dollar, which kind of indicates there's these positive spillover effects? Or does it increase by less than a dollar, which indicates it really isn't stimulating the economy tremendously. What we find is impacts that are less than one. We find a fiscal multiplier of about 0.3. So if you spend a dollar you get about $0.30 extra in output which really doesn't fit with the story of public R&D generating massive economic growth. We have this idea that there's these externalities from ideas. Ideas kind of make an economy more productive, so you can grow much faster. We don't really find that. We also don't find in the data much evidence for productivity increasing. Size gets bigger, firms hire more workers, they produce more output, but they don't really become more productive. We're not really seeing these kinds of big technological spillovers from the space race.

Smith: You also looked at the long-run productivity gains. Did you find an absence of gains in that area as well?

Whalley: The long-run effects are not especially larger. Sometimes people talk about a general purpose technology, such as AI right now, or, historically, computers. It takes time for firms to learn how to use that. There's complementary innovations that have to happen. So you would expect maybe the longer-term effects would be larger than those short-term effects. But we don't really find that. The space race ends obviously with going to the moon and returning in 1969. But we studied the data up until 1992. We don't really see much bigger effects in the late 80s and early 90s than we do in the 60s and 70s.

Smith: There are still politicians and public figures who call for new moonshot programs like those coming out of the space race. What are reasonable expectations for what these sorts of investments can deliver economically?

Kantor: I think the lesson from the space race is that the devil's in the details. What kind of R&D program policy are we implementing? Is it one that's going to advance basic science and our fundamental knowledge about something, whatever it happens to be? Or is it effectively an industrial policy where we're just shifting rents to some particular favored industry or company? We might not expect the spillover benefits in that case to be great, as opposed to funding fundamental science and fundamental knowledge. I think the space race is more in that applied industrial policy framework. I think that's why we're not really seeing big spillovers. It was a very specific historical episode where this engineering feat cobbled together ideas that were already existing. It just sped up the development of those ideas, but it didn't necessarily produce new things, new advances in knowledge.

Whalley: For the general public thinking about mission-oriented policy, you want to think about the value of completing the mission. How much do you value sending someone to the moon and returning them? That should be how you think about the space program. I think that should be how you think about these other specific mission-oriented policies, rather than just general spillovers that go everywhere."

To Beat China, Turn to India

Plus: There’s no need to embrace Beijing-style industrial policy

Letter to The WSJ. 

"Shyam Sankar’s recommendation that the U.S. copy China’s industrial policy is compelling but misguided (“Why the China Doves Are Wrong,” op-ed, Oct. 18). State-led industrial policy makes economies weaker, not stronger.

Researchers at Stanford found that receipt of billions of dollars in direct subsidies from Beijing was “linked with lower firm productivity growth and only modest growth in R&D spending in subsequent years.” A recent International Monetary Fund working paper argues that China’s industrial policy has led to reduced aggregate productivity.

To beat Beijing, we ought to allow its products to reach the hands of productive Americans. We have 12.7 million workers employed in manufacturing; China has some 212 million. That they only produce twice as much “manufacturing value” as we do despite having more than 16 times as many workers is evidence enough that we needn’t embrace their policies.

David Hebert

American Inst. for Economic Research"

'I, Sharpie' As An Antidote to 'I, Pencil' Is Truly Ridiculous

By Caleb Petitt of the Independent Institute.

"American Compass recently attacked economists again. Writing on the conservative think tank’s Substack, Chris Griswold attempted to debunk Leonard Read’s pro-global-division-of-labor essay “I, Pencil” with a post entitled “I, Sharpie.”

Read’s essay was written to inspire awe over the unplanned, spontaneous order of the market.  In it, a pencil explains the complex process involved in making such a seemingly simple thing. A pencil is made from wood, glue, graphite, clay, castor oil, brass, rubber, and more--materials that come from all corners of the earth to be assembled in a single factory. 

The pencil narrator draws attention to all the things involved in getting those inputs to the factory: the tools used by the various workers, the coffee they drink, the ships that transport the goods, the lighthouses that guide the ships, and the hydroelectric dam that powers the factory. The reader gets a good lesson in how the market’s price system coordinates the concatenation of countless efforts underlying the assembly of a mere pencil. 

The point of Read’s essay is not that human skill, knowledge, ingenuity, or entrepreneurship do not matter. It also does not argue that government policy does not or cannot shape incentives to change human action. Yet these are somehow the takeaways that Griswold attacked. The Sharpie narrating Griswold’s essay praises the judgment of the Newell Brands CEO for moving production to America. It criticizes the pencil’s awe at the “millions of tiny know-hows configurating naturally and spontaneously in response to human necessity and desire and in the absence of any human masterminding” by pointing out that pencils are made offshore. 

The Sharpie further praises the knowledge and skill of the people who made him and says that it had not “seen any invisible hands fix a single machine.” It claims that its story reveals an astounding fact: “business leaders decide where things are made, and policy can push them toward one decision or another. There is no mystery here, just political economy.”

If the Sharpie thought that would astound economists, it was wrong. Every economist knows that policies shape decision-making, and most economic research attempts to estimate the effects of policy on economic outcomes. Economists like Joseph Schumpeter, Ronald Coase, and Israel Kirzner pioneered the study of entrepreneurship and the theory of the firm; thus, business leaders’ entrepreneurial decisions about how to run their firms fit well within the scope of economic research. 

That pencils and Sharpies are made by skilled workers in factories does not conflict with the notion of the invisible hand. No economist claims that an invisible hand will fix a machine on a factory floor. Rather, the metaphor communicates the order that emerges unplanned in markets. 

Markets comprise billions of people with an incredible variety of plans. Prices guide those people as they attempt to coordinate their plans with others. The pencil’s praise of trade is a critique of autarky, or self-sufficiency; trading in the market frees people from the horrors of autarky. 

Finally, the Sharpie praises policymakers who shape incentives to bring manufacturing to America. The Sharpie could use some economics education on this point especially. The problem most economists are concerned about with government intervention is the second-order effects, not the immediate effect. For example, when the Trump administration raised tariffs on steel in 2018, it created about 1,000 jobs in the steel industry, but it destroyed approximately 75,000 jobs in manufacturing industries that use steel as an input. Economists are trained to look for those second-order effects that the Sharpie failed to notice. 

The Sharpie could learn from Read’s pencil or Adam Smith’s woolen coat: markets and prices help people coordinate to accomplish things beyond the wildest dreams of someone working in isolation. Interfering with those interactions can cause undesirable effects. Anyone, even a Sharpie, who advocates government industrial policy, which interferes with free trade, needs to account for the full scope of its economic consequences."

Trump’s Deals With Companies Aren’t Un-American. That’s the Problem.

The president’s wheeling and dealing with the likes of Intel and Nvidia echoes the bad old days for stock investors

By Jason Zweig. Excerpts:

"history suggests the likely results will be massive misallocation of capital and a surge in waste, corruption and conflicts of interest. For centuries, government has been the ultimate buy-high-sell-low investor, and that doesn’t bode well for anybody’s stock returns."

"In the 1820s, states competed furiously to fund banks, canals and railroads.

During the brief boom, dividends of stocks they’d invested in were one of the biggest sources of revenue for many states. After the bust, eight states plus the territory of Florida defaulted on their bonds.

In 1844, Pennsylvania began trying to unload its stock in local railroads. Fourteen years later, it had gleaned total proceeds of $11 million on its more than $75 million of investments. That loss is probably equivalent to something like $40 billion today.

After the states got burned, the federal government stepped in.

On July 4, 1828, President John Quincy Adams scooped out the first shovelful of the Chesapeake and Ohio Canal. The U.S. government was the largest shareholder, with a $1 million investment, roughly equivalent to $1.2 billion today.

Other than a flicker of prosperity in the 1870s, the canal “never paid any return,” a later historian concluded. The U.S. bought it out of receivership in 1938 for approximately $2 million." 

"stocks earned an annualized rate of return before inflation of less than 6% in the 19th century." 

With Intel, U.S. Has a Stake Without a Strategy

Trump’s forays into private business appear driven by money rather than an overarching plan to bolster American competitiveness

By Greg Ip. Excerpts:

"Intel’s problems date back decades. It grew fat designing and making the chips that power personal computers, then missed the boat on mobile phones and the graphics-processing units that drive artificial intelligence, where Nvidia leads.

Meanwhile, it lost the lead in manufacturing prowess to Taiwan Semiconductor Manufacturing Co., which pioneered the “foundry” model: making chips designed by companies such as Nvidia, Apple, AMD and Qualcomm.

Intel has since set out to compete with TSMC in foundry services. To help it finance the necessary fabrication plants (fabs), the Biden administration contributed $11 billion in grants and defense contracts from the CHIPS and Science Act, of which $2 billion has been disbursed. But Intel has struggled to attract foundry customers, and it has pushed back completion of a $28 billion fab complex in Ohio from 2025 to 2030."

"the U.S. would help Intel “to create the most advanced chips in the world.”

And yet the deal doesn’t provide Intel with new resources to accomplish that."

Why Americans Should Fear Washington in Intel’s Boardroom

Turning Intel into a government partner undermines competition and national prosperity.

By Vance Ginn. Excerpts:

"But once government crosses the line into equity ownership, the game changes. It’s no longer about setting fair rules of the road—it’s about Washington joining the race as a participant. That undermines competition, politicizes corporate decisions, and exposes taxpayers to risks they never agreed to take."

"Every dollar the government spends buying shares is a dollar it cannot use to reduce taxes, retire debt, or provide genuinely public goods. 

The resources are scarce, and putting them into Intel stock means less available for other, possibly more valuable, uses. Economists from Adam Smith to Milton Friedman have warned that when governments redirect capital for political reasons, the result is misallocation."

"Private investors demand efficiency because their money is on the line. Government officials, by contrast, make decisions based on politics. If Intel falters, will Washington push for restructuring and accountability—or will politicians double down to save face? History suggests the latter. 

From Amtrak to Solyndra, government ownership often locks in inefficiency rather than driving improvement."

"Once government owns part of a firm, special interests swarm. Lobbyists push for favorable regulation, subsidies, and procurement contracts that tilt the playing field. This breeds cronyism—where success depends on political access instead of innovation. 

Thomas Sowell put it plainly: “The first lesson of economics is scarcity. The first lesson of politics is to disregard the first lesson of economics.”"

"This kind of industrial policy is not new. Japan’s Ministry of International Trade and Industry (MITI) famously tried to steer the country’s industries in the 1980s, funneling state resources to “strategic sectors.” Yet the results were mixed at best. Japanese chipmakers, once dominant, fell behind precisely because competition gave way to cozy relationships with bureaucrats.

Closer to home, the federal government nationalized passenger rail with Amtrak in 1971, promising efficiency and profitability. Fifty years later, Amtrak still relies on billions in subsidies and remains unable to compete with private alternatives where they exist. 

Similarly, the 2009 federal bailout of GM and Chrysler made taxpayers temporary shareholders. The firms survived, but at the cost of distorting the bankruptcy process and politicizing capital allocation."

"Conservatives long criticized Democrats for pursuing industrial policy through the CHIPS and Science Act. Yet now, under Republican leadership, we see the same tactics—only bigger. 

If the right normalizes government equity stakes in the name of security, they will have no credibility left to oppose similar measures when the left expands them to other industries."