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Decentralizing Industrial Policy
Our vision for American industrial policy in the 21st century
By Ryan Li, Steve Krafcik, and Jai Malik
The CHIPS Act and the “Inflation Reduction” Act mark the return of an ambitious, centralized, national industrial policy. To many, the passage of both bills reflects an exciting bipartisan consensus that America must begin to build like it used to. Indeed, on principle, the bills echo priorities that hard tech founders, investors, and policymakers should fight for: supply chain resilience and true energy independence. However, while consensus on these priorities is clear and needed, it is far less obvious that Congress and our federal government should dictate industrial policy.
To the average citizen, national industrial policy is intuitive conceptually. In theory, funding from Congress can align market incentives with the priorities of the country to ensure large companies and individual states receive cash for tackling important issues. But as entrepreneurs and investors understand, tackling massive, structural problems often requires quick and targeted solutions managed by smaller organizations rather than slow, clunky incumbents. This insight is instructive for American industrial policymakers: leaner, more focused state and local governments may actually implement industrial policies with better results than the federal government.
The truth is that American businesses and citizens deserve better than the precedent set by the CHIPS Act and the Inflation Reduction Act. For example, the CHIPS Act is frequently criticized for focusing on the wrong problem entirely. A one-time subsidy to build a new semiconductor fab won’t address the fact that our Asian counterparts are simply better than we are at producing chips—they do it 50% more cheaply and 25% more quickly. Instead, we would be better off funding technological breakthroughs (i.e., alternatives to CMOS-based transistors) that might actually level the economic playing field for all American chip manufacturers. Directly incentivized by the local economic growth that would come from chip fab innovation, existing chip-manufacturing states like Arizona and Texas could establish new sovereign wealth funds to invest in companies working on these aforementioned new ideas—rather than old ones ad nauseum. The possibilities for funding industrial innovation are endless once we forego the assumption that the federal government must be front and center in these efforts.
Taking a step back, the belief that industrial policy should be a national matter is a mistake for numerous reasons. The most obvious problem is that federal industrial policy is often motivated by political goals rather than economic goals. In fact, one has to look back as far as World War II for industrial policy carried out at the federal level that was primarily motivated by economic needs. In 1942, FDR established the War Production Board by executive order to oversee the conversion of civilian industry to successful war production. The immense power of the federal government was helpful when focused on a single, immediate, and economic goal—the production of military equipment during wartime. However, federal intervention is less helpful in peacetime when industrial policy is more nuanced, future-looking, and best accomplished through creativity and trial-and-error.
The subsidization of clean tech in the late 2000s is an illuminating example of politically motivated industrial policy leading to economic waste. Despite over $150B of federal funding in clean tech over a half-decade, there were very few energy cost reductions or productivity gains. While the nascent industry was always a risky bet that would require sophisticated, tailored policies to promote, the federal government's haphazard approach to spewing funds across every region of the country and various niches of the industry was unfocused. Billions of taxpayer dollars were sunk into companies developing vaporware, such as Solyndra. Political calculations distorted the government's investment decisions, as Energy Department officials later acknowledged they felt tremendous pressure from political officials and appointees to process certain loans. Detached from budgetary constraints and unpressured by voters indifferent to the details of geographically dispersed industrial policy, federal legislators and agency heads have historically been incentivized to produce broad political wins—not returns.
In fact, the broad geographical dispersion of national policies illuminates the fundamental flaw with the federal model: industries concentrate regionally, not nationally. Iron and steel manufacturing historically anchored the Midwest, automotive factories were a Detroit specialty, and the computing hardware revolution was a Silicon Valley phenomenon. Even in today’s world, industries continue to cluster regionally. For example, Southern California has become an aerospace innovation hub. Almost all new space companies (e.g., SpaceX, ABL, Relativity, Astra, Virgin Galactic, and more) are now headquartered there. And, across the Rockies, Wyoming’s slew of crypto-friendly legislation has turned the state into an unlikely hub for Bitcoin miners and cryptocurrency banks like Avanti and Kraken.
If industry naturally contours around localities, state and local governments are the obvious conductors of industrial development, not the federal government. State and local governments can more easily observe market tendencies clustering certain industries within their borders and adopt more creative policies to further that development. For example, Miami Mayor Suarez has successfully used unconventional strategies like hosting long-form conversations with high-profile tech guests to rapidly help Miami accrue cultural capital in the national tech scene. Alternatively, these smaller, more entrepreneurial governments can also be the first movers to attract developing industries without a home. Either way, the risk inherent in industrial policy is mitigated when run through the focused lens of state and local governments.
While the risk of regulatory capture is omnipresent in all government interactions with industry, it is lesser at lower levels. One direct reason is that state and local voters are closer to state and local government decisions, so they’re armed with better information to hold their representatives accountable for poor industrial policy. They see firsthand a boarded-up factory or the public services cuts that result from poor state policy. In contrast, it was an oddity that the average national election voter had even heard about Solyndra (and still, no federal officials were directly held accountable). Many other failed, high-cost federal policies often go unnoticed. Moreover, state officials must be more attuned to the economic value of policies they propose, which further leads to more sensible spending. Whereas the federal government can and does run a massive deficit, local and state governments often cannot because of balanced budget requirements.
The power of local and state government was clearly demonstrated in Southern California, where the town of Torrance courted L3 Technologies—a familiar play by the many local governments in the region who shepherded a burgeoning aerospace industry. After reaching out to local officials, the L3 team received numerous suggestions to take advantage of little-known tax credits and utility and talent-training reimbursements. The Mayor of Torrance even personally came to one of their company meetings and waived their $35,000 business license renewal fee for the year. L3 Technologies could never have gotten such focused assistance from a member of Congress, or an official in some federal agency. And, if the company tried, it would be entering the hugely expensive, complicated, and cloistered world of federal lobbying—an inaccessible place where developing companies have significant competitive disadvantages. In contrast, local governments, like Torrance, offer an entirely different value proposition: they can be a true partner to startups and emerging companies. By offering founders and executives direct lines of communication to decision-makers, local and state governments build genuine, enduring relationships with growing companies.
As the local government in Torrance proved, decentralizing industrial policy is not just important for the future of governance. Most importantly, it is imperative for the future of hard tech companies. Imagine an America where states and localities have developed industrial specialties that benefit different hard tech companies. For example, with its proximity to large reserves of timber and other organic building materials, North Carolina could provide corporate tax breaks for construction and building materials startups. Furthermore, with a potential economic overreliance on oil and natural gas, Texas could implement a policy of matching venture financing with equally sized non-dilutive grants for clean energy startups that choose to HQ in-state. These specialized policies would additionally cluster top engineers in different parts of the country, driving further innovation (and tax revenue) through talent concentration, a key component of hard tech startup success.
Of course, the federal government still has a role to play in shaping the industrial direction of the country. As the final arbiter between smaller jurisdictions and the largest fund allocator, the federal government should incentivize state and local governments to drive policy innovation. For instance, the federal government could set priorities for certain industrial development and condition direct funding awards to the state and local governments that best succeed in accomplishing them. Alternatively, the federal government could consider a request for proposal system in which state and local governments petition a federal agency with a fully-formed industrial policy, and, if approved, receive some level of matching funding. Finally, as state and local governments more efficiently direct specific industrial policies, the federal government can focus on improving the general competitiveness of the U.S. business environment. Streamlining regulation, managing debt spending by cutting failing programs, and easing the immigration process for highly desired workers are good places to start.
In sum, rebuilding the American industrial base will require a concerted effort to innovate from both private companies and policymakers. The role of the latter should be to incentivize and accelerate progress in the former, and policymakers themselves should be incentivized to perform that task as well as possible. Federal officials do not have such incentives, and, subsequently, federal projects are notoriously slow, expensive, and ineffective. With the largest financial war chest in the world, the federal government can instead fund creative regional policy proposals with large rewards to encourage competence and cost efficiency. Through this, we can realize a new era of decentralized American industrial policy—where companies compete and drive hard tech innovation forward while state and local policymakers also compete to drive policy innovation forward.