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How Government Intervention Strengthened the American Economy

Last week, the "Rebuild America Act" was introduced by Sen. Tom Harkin. This comprehensive bill aims to help American manufacturers compete and help young people get the education they need.  It calls for rebuilding roads and bridges, improving schools and job training, and protecting U.S. companies from predatory trade practices.

Bills like these raise the question of what role (if any) the government ought to play in making the American economy stronger. According to many, government should play no role. It should simply stand aside. Those who hold this view believe that when government steps in, whether through taxes or regulations or subsidies or investments, things just get worse.

This theory is popular, simple, and easy to explain—but it's wrong.  It flies in the face of the principles that have made America strong throughout its history.

Driving into the future

Let's start at the beginning. In the early 1800s the United States had no industry to speak of; we grew cotton and exported it to England. English mills turned the cotton into clothes and sold the clothes back to us, at a big mark-up. We shipped fur pelts to the French who turned them into hats and sold them back to us. This was a prescription for America to be exploited, not for America to prosper. The U.S. government, tiny and weak though it was, realized the importance of industry and took a bold risk to move America forward. The government taxed imported manufactured goods. It protected America's fledgling manufacturers so they could reach the scale they needed to compete with factories abroad.

You can imagine how unpopular this strategy was among the growers and fur trappers! Growing, trapping, and timber were the dominant extractive industries of their time, just as coal and oil are today. The investors and owners in these industries fought the new policy with all their might. The rhetoric of the time was as harsh and polarized as anything said today.

Despite intense criticism, government policymakers stuck to their plan. America quickly became a powerful industrial nation. Then, the government pulled back and forced companies to compete on their own. This is exactly what government should do. The combination of supporting key industries, then pulling back, gave America a powerful economic base that carried us through two world wars.

This kind of limited, strategic support for new industries has helped us many times since. In aviation, semiconductors, and the Internet, direct government investment and protective measures helped American companies achieve a long and successful run.

Let's not fool ourselves. The decisions in industrial policy are not easy. Not every bet pays off.  It requires political courage to pull the plug on programs that are failing or obsolete. For example, subsidies of agriculture and oil should have stopped years ago. Programs must be structured correctly. For example, the government should avoid picking favorites among companies, even while supporting an industry as a whole. (The effort to pick favorites killed the computer companies in most European countries.)

Although these decisions are hard, we can't ignore the challenge. When we fail to develop strategic industries, we allow other countries to dictate our future. This threatens American productivity, prosperity, and ultimately our security. You don't need a Ph.D. in economics to know that money flows to places where industry leaders concentrate. That's why Silicon Valley, Hollywood, New York, and Boston are prosperous.  A 21st century economy can't survive on lattes and manicures.

I am stunned that so many American politicians have abandoned the strategies that made America great. For the past 30-40 years we've cut back on long term action to develop the economy. We have left everything for the market to work out. Politicians who would never cede power to an unaccountable international court are eager to cede our livelihood to an unaccountable international market.

How has the American economy done with less government involvement in the economy? Not so well, it turns out. Despite much lower taxes, economic growth is down. Incomes have flattened for most people. Unemployment remains high. Measures of U.S. innovativeness, such as the number of patents granted, have slumped relative to other countries. Educational attainment has fallen. American workers are losing their productive edge.

As a former consultant who has worked with many leading corporations, I believe a vigorous competitive marketplace is the heart that pumps life through a modern economy. At the same time the government plays an essential role. Government must create and maintain the conditions in which competition can flourish. This leads to better products and services, lower prices, and good jobs. With the right market structure and incentives, competition thrives and society benefits. Now is not the time to ask government to stop doing its job. Now is the time to demand that government do its job right.

April 26, 2012

(A version of this was posted earlier at www.usnews.com)