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Written by: Tim Pierotti
The above chart illustrates the recent surge in construction manufacturing which accounted for 20% of GDP growth in Q1'23. That’s right. 20% of GDP growth came from a sub-sector of the economy that normally accounts for only 1% of GDP. The vast majority of this investment boom is in semiconductors fabs, battery technology plants and all the electrical components vital to not only the energy transition but also to long-term national security. Churchill’s famous quote, “Never let a crisis go to waste” was not lost on the Biden administration and Congress. The spending has been financed via the Inflation Reduction Act (IRA) and The Chips and Science Act. The incentives provided by that legislation have led to massive private investment in domestic manufacturing.
One result has been that the lags from this fiscal largesse are, in part, offsetting monetary tightening. Last week Larry Summers said, “I am profoundly concerned by the doctrine of manufacturing-centered economic nationalism.” The Former Treasury Secretary went on to express concern that the immediate problem at hand is labor inflation and to finance the rapid redomiciling of manufacturing capacity is clearly exacerbating secularly tight labor markets.
Adam Posen of the Peterson Institute, an economist and tireless advocate of more global trade wrote this recently:
“They (the Biden administration) are still trying to divide major parts of the world economy, including China from the EU. Along with export controls and investment reviews, their big initiative is the subsidies war in manufacturing that they have launched through the IRA and CHIPS Acts…Society ends up with entrenched incumbent companies becoming a political sacred cow, as we have seen with state owned enterprises and banks in China. You cannot reduce employment, or shift the location, or let competition come in from either the outside or the inside. You have accumulating unfairness from incumbent companies’ political weight being thrown around. You crush new entrants and dynamism.”
Posen concluded his essay writing, “The supposed national security gains against China from this aggressive de-risking are not worth the clear costs.” It is on this final point where the debate lies. Xi has demonstrated that he is an unreliable and potentially hostile partner and therefore proactive vigilance is warranted. But, even good policy choices come with negative consequences. While I have no doubt that there will be benefits to our national security from these efforts, there will be negative unintended consequences as well. Summers and Posen are likely right that this policy is cyclically and secularly inflationary and that this level of governmental interference in commerce will damage our economic dynamism in the longer-term.
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