A new Washington Consensus?

American economic policy has shifted towards government intervention, including industrial policy and away from free-trade. US National Security Adviser Jake Sullivan set out the powerful rationalisation in his April speech.

How should Australia respond? Our situation is very different. Let’s count the ways.

Sullivan’s speech articulated several objectives, which provide a basis for the discussion. Expanded industrial support, emphasising high technology (computer chips) and climate change (electronic vehicles and batteries). More “good jobs” for blue collar workers. Restrictions on trade with China. Each of these elements is part of the overall geo-strategic response to the rise of China.

Industrial policy is far more likely to succeed in America than in Australia, but still has a mixed record. Proponents quote DARPA’s role in the computer/information revolution and the technological marvel of NASA’s moon landing.

Bidenomics has certainly boosted industrial investment, and trade restrictions are encouraging leading foreign car, battery, and chip makers to set up in America.

The fundamental difference is scale: America is big enough to provide a viable domestic market. Australia is not. A big market is needed to persuade leading foreign brands to set up shop. The sad history of car-manufacture in Australia illustrates the problems.

Asian success in industrial development (notably South Korea) was always export-oriented. Very low labour costs gave firms comparative advantage, foreign investment gave them technology, and exports gave them scale.

Trade presents a similar difference. America’s diversity in human and natural resources allows it to be at the autarchy end of the trade spectrum – its import + export share is 25% of GDP, compared with Australia’s 40%.  Australia has narrow comparative advantage – mainly resources, but also some services such as education and tourism. Not only is it narrow, but it is a perfect fit with China’s needs.

Looking over the next decade or two, Australia’s ongoing high living standards depend crucially on the Chinese market. Within this time horizon, there is no realistic diversification that can alter this dependence. Selling barley to feed Saudi Arabian camels is less profitable than selling it to Chinese beer brewers.

Further ahead, if climate change contracts Australia’s coal and LNG exports, renewable electricity is the best chance of a substitute. This would, as a bonus, greatly enhance national security by reducing energy imports.

The second element – “good jobs” – is usually equated with industrial jobs, but in the information age, this is no longer true. Manufacturing is a much smaller component in the workforce in all rich countries, not only because of China, but because technology has replaced workers. Output has shifted towards services – education, health, aged-care, tourism, entertainment and so on. This is where the future “good jobs” will be.

The third issue – climate change – should be seen as an opportunity as well as a challenge. Australia has outstanding comparative advantage in one key element of the response – generating electricity with solar. Australian research made a huge contribution to the efficiency of solar panels. If, as seems likely, exporting green energy such as hydrogen will be difficult and costly, Australia will have outstanding comparative advantage in heavy industries and refining (steel, aluminium, lithium) as processing shifts to renewable electricity.

Sullivan’s fourth objective – ostracising China – makes no sense for Australia. Current policies seem sensible. Australia shouldn’t provoke China with unnecessary official commentary on Covid origins or human rights. At the same time, the country should not tolerate domestic interference or foreign bullying.

Australia should maintain tight security over sensitive issues (not just aimed at China), but continue to welcome Chinese students at universities and into research labs.

On industrial policy, Australia should not start with a purist neo-liberal no-government-interference mindset but should recognise the dismal track record. Vehicle batteries, solar panels, computer chips and all similar large-scale industries that are generously subsidised overseas should be avoided.

Government money is better used to promote public goods such as research (especially that related to climate change), infrastructure (especially the electricity grid), and to ensuring that government-provided services such as education are oriented towards the needs of the transition away from fossil fuels.

Nevertheless, this should not preclude assistance to specific enterprises which, in a risky and second-best world, are pioneering climate-related projects, as is already occurring. In industries where Bidenomics is “eating our lunch” by drawing investment and skilled resources away from our comparative advantage (e.g. hydrogen), there is a good case for policy response. But rather than focus on the reasonableness of spending $100 billion to promote climate change, better to explore the specifics of projects that are firmly based on comparative advantage.

Perhaps the most vexed issue is foreign investment. At present, Australia is open to all, although the Foreign Investment Review Board has become more security oriented. It might be better to formalise the ownership limitations, and where there is a shortage of domestic financing, stepping in with government participation. Australia shouldn’t allow pleas from customers for more coal and gas production to divert the country from its climate change objectives.

Sullivan welded all the elements of Bidenomics seamlessly into America’s geosecurity priorities. The suggestions made here would make Australia look quite different, and much less hostile to China. So be it. Geography, size and national interests are quite different.

The Biden administration’s “modern American industrial strategy” marks a striking departure from prevailing economic orthodoxy. The United States is now championing muscular government intervention to combat the climate crisis, rebuild America’s industrial base and counter China’s rise. Yet rather than signalling the beginning of a post-neoliberal era, the US industrial policy turn – and the nascent European response – may foreclose green development pathways and exacerbate disaffection with the existing global economic order.

US National Security Adviser Jake Sullivan is right to concede that “trickle-down” economics has enabled “unchecked corporate concentration” and “hollowed out” national industrial bases. Recent speeches by Sullivan and US Treasury Secretary Janet Yellen formalised the United States’ shift away from neo-liberal policy prescriptions, which originated in the passage of the Inflation Reduction and CHIPS and Science Acts.

But the “new Washington consensus” goes far beyond revising US economic policy positions. Instead, the United States has integrated its economic and national security strategies through a geoeconomic approach to US–China competition. The United States – and indeed the entire G7 – now seeks to de-risk from China. Yellen speaks of a “friendshoring strategy” to create “redundancies in our critical supply chains with the large number of trading partners that we can count on”. This approach constitutes a concerted attempt to diminish Western dependency on China, while creating new economic opportunities for the United States and its allies.

Friendshoring ensures that the economic benefits of the US industrial policy turn are concentrated among “trustworthy” allies. The United States has now promised to add Australia – a potential green mining superpower – as a “domestic source” under the Defence Production Act, matching the preferential economic treatment provided to Canada and Mexico. Australian Trade Minister Don Farrell has subsequently lauded a coming “golden age of mineral exploration” for Australia.

Yet for US industrial policy to be effective, only very few countries can receive such treatment. Most of the world will instead be required to compete with the United States and its chosen “friends” – a formidable task given the sheer size of the US subsidy regime. Even Europe is now facing the prospect of protracted transatlantic industrial policy competition. Nevertheless, Europe’s economic strength means that it will at least be competitive in a green industrialisation race.

The same cannot be said for the many low- and middle-income countries that lack the revenue base to implement similar government subsidy regimes. Historically, countries such as South Korea, Taiwan, and China have implemented targeted industrial strategies to fast-track their development, while Western states hued to neo-liberal orthodoxy. Industrial policies served as a corrective to global economic inequalities, creating development opportunities that otherwise wouldn’t exist. But a Western industrial policy race to the bottom would render low- and middle-income country industrial strategies at best defensive economic survival measures, rather than drivers of sustained development.

Even Brazil, Indonesia, Peru and Türkiye, which are poised to benefit the most from the unique resource demands of the green transition, could be eclipsed by well-resourced US “friends”. A much worse fate awaits any country perceived to be a national security threat to the United States, as evidenced by the United States’ essential decoupling from China on so-called critical technologies – a policy that Sullivan terms “a small yard and high fence”. And national security is a notoriously broad and malleable concept, providing the United States with a justification for expanding the “yard” if needed.

To promote global “green” development, the G7 has so far done very little. The Partnership for Global Infrastructure and Investment remains incremental, especially in comparison to China’s Belt and Road Initiative. Climate finance spending has lagged behind pre-existing commitments. Regardless, these measures fail to meet the aspirations of middle-income countries such as Brazil, India, Indonesia and South Africa, which see US–China competition and the green transition as opportunities to redistribute global economic and political power. Instead, current commitments essentially leave development pathways to the discretion of Western powers, enshrining existing economic hierarchies and inequalities.

It is hard not to see the Western industrial policy turn, in its current form, as an ambitious attempt to sustain Western predominance, with exceptions for countries such as India that pledge their geopolitical allegiance, albeit imperfectly. This suspicion is heightened by the recent US-led denouncement of “non-market” industrial policies and “pervasive subsidisation” – an organised hypocrisy so flagrant that co-signatories such as Australia have been remarkably muted in promoting the declaration.

The most likely outcome of the US-led attempt at “defying gravity” is, intuitively, responsive geoeconomic counter-balancing, such as the proposed creation of an “OPEC for lithium”. This approach is evident in Indonesia’s non-World Trade Organisation compliant ban on raw nickel exports, which has supercharged its domestic nickel refinement industry but remains an obstacle to any future US–Indonesia critical minerals trade deal.

The United States should recognise the inevitability of economic multipolarity and instead lead the trillion-dollar global investments required to deliver both rapid decarbonisation and sustainable development globally, rather than rely primarily on invoking the alleged positive spillovers of its domestic investments. Such leadership would be incredibly costly but generationally important. It would overcome the false dichotomy between sustainable development and the green transition and cultivate a positive-sum logic of North–South green transition collaboration rather than inciting cycles of geoeconomic competition.

Did US National Security Advisor Jake Sullivan’s “New Washington Consensus” speech on 27 April signal the end of the neo-liberal order, when free markets had a paramount role in an economy dominated by private-sector enterprise?

Gary Gerstle’s book, The Rise and Fall of the Neo-liberal Order, provides useful perspective to the Sullivan speech. It fits America’s modern economic history into two “orders”: the New Deal Order, beginning with the Depression and ending with the stagflation of the 1970s; and the Neo-liberal Order, beginning with the election of Margaret Thatcher and Ronald Reagan and perhaps ending with the global financial crisis (GFC) in 2008.

The New Deal Order began in an economy with a tiny role for government – the top rate for income tax was 7%. The architect of the New Deal, Franklin D. Roosevelt, was an economic activist but on a small scale. The US government’s role was supercharged by the Second World War and came to maturity in the three post-war decades. Roosevelt was a pragmatist without a clear economic doctrine: Keynesian macro-management came later, and with it a burgeoning role for governments in the provision of social services (education, health) and infrastructure.

The 1970s’ stagflation discredited macro-economic policies. There was also disenchantment with the demonstrated deficiencies of government services and enterprises.

Thus began Gerstle’s Neo-liberal Order, backed by the powerful rhetoric of libertarians such as Milton Friedman. The coincident election of Thatcher and Reagan looked like a watershed order-changing moment.

Meanwhile, academic theory promoted the “efficient markets” hypothesis: free markets would provide optimal guidance for production and output.

This era brought productivity-boosting economic reform. But it also brought income inequality and industrial decline for Western economies as China became “manufacturer to the world”.

The 2008 GFC should have dealt a heavy blow to the “efficient markets” view, especially in its heartland – the financial sector. However, neither the GFC nor the limp recovery afterwards changed much. There was dissatisfaction (see “Occupy Wall Street”), but as no viable alternative was on offer, not much changed.

This near-century period looks like evolution rather than libertarian revolution. The continuities are more obvious than any epoch-defining breaks.

Throughout, markets continued their central role in allocation, while at the same time regulation increased, reflecting technology and complexity. As living standards rose, demand expanded for the kind of services that only governments will provide.

How does all this fit with Sullivan’s New Washington Consensus? Viewed in the context of the huge changes encompassed in Gerstle’s two “orders”, Sullivan’s economic changes are just a tiny tweak. Sullivan is belatedly putting rhetorical flesh around the already-announced policies in the Inflation Reduction Act, the CHIPS and Science Act and the Infrastructure Investment and Jobs Act.

We should note that John Williamson’s original Washington Consensus was a middle-of-the-road common-sense articulation of the indisputable advantages of markets and international trade, rather than libertarian dogma. Sullivan’s economic initiatives would easily fit within the old consensus.

International trade openness is an important marker distinguishing economic regimes – putting autarchic Cuba and North Korea in a different category from America or Australia. But openness is one of the continuities in American policy: free trade was consistently and loudly advocated, even if never perfectly implemented. The liberal side of politics – the Democrats – was always ambivalent about the benefits of free trade. Sullivan’s interventions are well within the quite flexible parameters that characterise the norms of trade openness – and America’s past trade restrictions.

On tariffs, Sullivan says that the intention is to put “high walls around a small yard”. Compare this with Europe’s pervasive agricultural protection, so deeply embedded that it goes without comment. On industrial policies (subsidies and trade protection), major countries routinely give domestic-production preference in defence procurement – just one example of the pervasiveness of industrial policy. Post-Second World War America has always had large government projects and industry subsidies: Eisenhower’s highways; Kennedy’s man-on-the-moon; US Department of Defence (DARPA) technology subsidies,  Tesla’s electric cars and Solyndra’s (failed) solar panels.

Subsidies to offset the market’s inability to address climate change are advocated almost universally. Active labour-market programs to address income inequality and soften industrial transition are found in many countries and have long been advocated for America.

In short, Sullivan’s New Washington Order falls well within the economic mainstream.

The element that makes the Sullivan speech seem of greater import is the unambiguous priority of security over these widely-accepted economic norms. US Treasury Secretary Janet Yellen’s speech earlier in April carried the same message.

We don’t have an analytical framework to weigh the supposed security advantages against the economic costs. Commentators have noted the doubtful security benefits. Here, we concentrate just on the economic costs – to America, and to its trade-partner allies.

America, as a huge, resource-rich flexible and diverse economy, pays only a small efficiency cost for these interventions. The main distortions will be in the response of smaller less-diverse economies.

“The strong do what they can and the weak suffer what they must”. How should Australia react? As a beneficiary and active proponent of multilateral open trade, Australia has been guided by the idea that, just because your trading partners put rocks in their harbours, that doesn’t mean you should also do so. In any case, we don’t produce the high-tech products that are Sullivan’s focus. So, there are no trade policy implications for us.

US President Joe Biden’s climate-change initiatives, however, fall squarely into Australia’s comparative advantage: Australia’s has great potential to be a major global force in solar/wind-based electricity industries. Is America “eating our lunch”?

The climate challenge is so large that there is room for both countries (and others as well). The issue, however, is that Biden’s incentives may artificially suck scarce capital and expertise away from Australia.

We should overcome our usual well-founded presumption against industrial policy. This is the exception to the rule: a legitimate “second-best” argument for matching the incentives provided by the Biden initiative, at least in those aspects where we have clear comparative advantage – industries that require cheap, plentiful electricity, such as green hydrogen. Redirecting our current misguided industrial policies, notably domestic production of nuclear-powered submarines, would be a big step towards economic efficiency and enhance our energy security at the same time.

US National Security Adviser Jake Sullivan recently described the industry policy inherent in the Inflation Reduction Act (IRA) as the “new” Washington Consensus. In an issues paper released by Think7 last week, we argued for a “revised” Washington Consensus. While both the “new” and the “revised” Washington Consensus are aimed at addressing some of the same problems, the approaches are at odds. In the “new” approach, a proactive industry policy is seen as the solution to inequality arising from the loss of well-paid middle class jobs and to geostrategic risks from reliance on global supply chains. The “revised” proposal, while it does not rule out industry policy, aims to fix the fundamental problems with the failure of the original ten principles to deliver inclusive economic growth.

The Washington Consensus was a set of empirically based principles for what countries could do to promote economic growth. Coined in 1989 they reflected the experiences of Japan, South Korea and Taiwan in opening up their markets for trade in goods and capital. Domestic fiscal discipline – both in revenue raising to cover expenditure – and a commitment to rule of law, laid the foundation for a stable macroeconomic environment. Access to markets along with a supply of cheap disciplined labour and privatisation of state-owned firms made the countries attractive to foreign investors, who brought technology as well as finance.

The formula worked well in many places. Australia adopted much of the Washington Consensus in the mid 1980s. Competition from imports and for mobile international capital drove productivity growth, but it came at a cost of structural adjustment. And for the United States, which had largely modelled the principles, this turned out to be problematic in ways that the “new” Washington Consensus seeks to fix.

Structural adjustment is an ongoing process in economies as the demand for goods and services produced in a country change over time. Some industries grow, while others contract and can disappear as other regions or country’s producers expand.

In the United States, as in Australia, many of the contracting industries were concentrated in regions that had few other industries. Advances in robotics was working at the same time to reduce the share of labour in manufacturing, weakening the power of unions to negotiate higher wages for the remaining workers. Economics – at least the neoliberal version – assumed that other industries would expand to use the resources left redundant by the closure of manufacturing industries. Alternatively, the theory assumed that people would move to where the job opportunities were expanding.

There are a host of good reasons why people don’t move, and few want to take lower paying jobs. These forces drove the place-based “hollowing out of the middle-class” that has fed populism. It is this problem that the “new” Washington Consensus seeks to address through massive place-based subsidies for green industries.

The focus on green industries in the IRA responds to another perceived failure of the Washington Consensus. The ten principles of the Consensus are silent on externalities – whether local pollution or degradation of the global commons. The IRA aims to help the United States move toward reducing their contribution to carbon emissions. But as the atmosphere is a global common, the effectiveness of the IRA in lower emissions will be partially offset if it raises the cost for other countries to reduce their emissions relative to a more globally cooperative and efficient approach.

The revised Consensus we propose in the Think7 issues paper adds a principle that firms should be charged for their contribution to pollution, including carbon pollution, by the governments in the countries where they generate this pollution. The G7 countries were asked to impose this requirement on their multinationals, and to encourage the G20 countries to follow suit.

Globalisation has played a role in widening inequality within countries, but the problem is deeper than wage competition between countries within industries. Despite deregulation, markets are getting less competitive, big firms use market power to influence policies, and the share going to small firms and most workers has fallen. The financial industry has proved effective at socialising the losses, while keeping the gains.

The new Washington Consensus does not tackle the problems of growing market power, nor the inherent problem that unfettered market mechanisms widen inequality. The revised Washington Consensus takes on these problems, recommending that the G7 countries reconsider how they can redistribute the opportunity for human progress within their own economies, and use this, rather than reaching for protection and nationalism, to address risks to domestic instability.

The revised Washington Consensus also asked the G7 countries to work with the G20 countries on a set of global trade and investment rules that give more agency back to governments to collect taxes for the services their country provides, be compensated for negative externalities imposed, and to create opportunities for the Global South to benefit from the engine of growth that international trade offers.

Senior figures of the Biden administration have given two critical speeches on US economic policy. First, Treasury Secretary Janet Yellen last month set out the parameters of US-China economic relations, attempting to make clear that Washington was not driven by a compete-at-costs logic in its relations with Beijing. Some have described it as a laying the “terms of the economic peace” with which Washington was prepared to live. While couched in the language of competition, Yellen signalled a desire to cooperate where possible and to avoid a major decoupling of the world’s two most important economies.

Then last week National Security Adviser Jake Sullivan addressed the Brookings Institution on “Renewing American economic leadership”. While using a similar tone as Yellen, Sullivan sketched out a blueprint for American international engagement that, were it to come to pass, would represent a post-neoliberal orthodoxy for America’s approach to the global economy. For decades the United States has underpinned a liberal model for international economic relations, advocating unswervingly for the power of markets, price signals and the profit motive as the critical components of optimal economic organisation. Sullivan has laid out a vision in which state guidance of economy matters becomes pre-eminent.

Sullivan argued that there were four reasons for administration’s change of direction. First, market forces untrammelled by the state had hollowed out America’s industrial base. Second, geopolitics had returned with a vengeance and neoliberal orthodoxy had weakened the United States in critical eras and provided key vulnerabilities in others, most obviously in semi-conductor production. Third, the climate crisis had been created by a classic market failure and finally, unfettered markets had created intolerable levels of economic inequality.

To address challenges that Sullivan frames in suitably epochal terms, state power must be brought to bear on how markets function. The speech was very high level, operating on matters of principle rather than practical details, but it made clear that the Biden administration was preparing a wide array of means to advance its ambition to rebuild America’s industrial base, better equipping its economy to grapple with great power competition with China, combat climate change and reduce inequality. These include public private partnerships, rewriting economic rules, as well as provision of economic incentives and subsidies to shift firm behaviour and investment choices and the creation of somewhat nebulous “economic partnerships”. These appear aimed to see off concerns from US allies and friends concerns about what looks suspiciously like the return of mercantilism.

While the four challenges Sullivan described are significant in-and-of-themselves, the fact that it was the National Security Adviser who sketched out the contours of this new economic landscape makes plain that preeminent motive force for this shift is security concerns about China. That said, given the fractured politics in America, the perceived threat from China is just about the only thing both sides of US politics can agree upon. It may be that a way to get traction on these issues is to define it as a means of tackling the China challenge.

Besides, critics of the liberal economic orthodoxy will take great heart from this shift in policy orientation from the world’s most important economic actor. Yet Sullivan’s reasonable tone and moderate claims belie the scale of the change that is in offing as the Biden administration seeks to rein in markets and use industrial policy to prosecute a multipronged gambit that could fundamentally reorder the global economy.

In some respects the Biden administration has already started down this path with the Inflation Reduction Act and Chips Act from 2022. They provide a welter of subsidies, tax breaks and loans to encourage investment in US semi-conductor production and green technology manufacturing base. The policies appear to be attracting investment. But they also illustrate the complexity of trying to reshape markets. For example, many electric vehicles assembled in the US by firms from “friendly” countries are ineligible for the tax breaks because of the many countries from which components are sourced rule them out of the current arrangements.

Some fear that the United States is trying to recapture markets and industry it lost to friends and partners, as well as putative enemies. To try to mitigate this concern the Biden administration has proposed a series of mechanisms to allow countries to coordinate on policy choices to “align incentives” so that market distortions can be minimised. These include the Indo-Pacific Economic Framework (IPEF) and the US-EU Trade and Technology Council. But these are both nebulous proposals. Even if they work as intended – and IPEF in particular does not provide a great deal of reassurance on that front to date – they will create a bewildering array of distortions in markets, with consequences which are extremely difficult to discern, apart from the reality that they will increase cost and decrease efficiency.

Sullivan describes this internationalised industrial policy as intended to increase resilience, reduce risk and be more economically inclusive. But stripped of such high-minded rhetoric, it is not just about increasing American self-sufficiency in semiconductors and green technology, but about choking off China’s growth in key areas. Sullivan talks of protecting technology with “a small yard and high fences” yet it has maintained Trump-era policies to undermine leading Chinese telecommunications firms. Deliberate or not, this is reinforcing the sense in Beijing that Washington intends to contain China’s growth and limit is potential prosperity. This risks a further fuelling mutual suspicion and ill will.

The larger trend is clear: geopolitical concerns are now fundamental to the operation of markets. The end of the Cold War ushered in a period of liberal optimism in which competition between states was subordinated to the logic of the market. Biden’s move to reorient US economic policy shows us that we are now in an era in which markets will be subordinate to the logic of geopolitical competition. And that is one in which growth will be lower, costs higher, and risks of war are much greater than before. A grim future, indeed.