Six rules to guide the West’s efforts to counter China’s industrial policy

Industrial policy is back — in the U.S. and UK, at least. In China, it never went away; in fact, it’s expanding into new technologies, and even into space. Indeed, it’s the success of China’s industrial policies, combined with China’s wolf warrior engagement with the rest of the world, that has spurred the revival of industrial policy in the West.

Having served in government during earlier bouts of enthusiasm for industrial policy, I can offer a few lessons to today’s policymakers.

At the start, we should recognize that letting governments pick economic winners and losers is wasteful, inefficient and corrupting. For the West, and open capital-market economies such as the U.S. and the UK, it’s hard to think of a worse policy — other than the alternative, which is to let China pick winners and losers for the world. 

So, we need a way to counter China without making a politicized mess of everyone’s economy. As they embark on that effort, here are six rules I’d commend to Western governments.

First, they should focus on industries that support the fundamentals of national security — fighting and spying. China certainly does. If Chinese subsidies can boost its communication companies into global dominance, for example, the investment will more than pay for itself in the intelligence that those companies can help China collect. The same is true for other civilian industries, such as the computer chips at the core of most weapons systems.

Second, Western industrial policy will create less economic distortion if it adopts a defensive policy — one that counters distortions created by China’s actions. Luckily, China is a big country that can’t carry out its policies without publicizing them. So, we know which of its industries China wants to turn into world-beaters. It has targeted areas such as artificial intelligence, quantum computing, 5G, the internet of things and, most recently, satellite telecommunications, which the Chinese national development commission added in 2020 to its list of government supported “new infrastructure.” (Losing no time, China has since announced plans for a 13,000-satellite competitor to Elon Musk’s low-earth-orbit swarm of Starlink satellites.) 

Third, it’s a lot easier to preserve an industry than to get one back after it’s gone. This is a lesson the U.S. is learning the hard way as it tries to avoid dependence on cheap Chinese-made drones, with their 70 percent global market share. Industrial policy works best when there’s a domestic industry to support, even (or especially) one that’s struggling.

Fourth, saving a struggling but viable industry doesn’t always require money, but it will require clear-eyed compromise and new forms of international cooperation. When I ran policy for the Committee on Foreign Investment in the United States (CFIUS) within the Department of Homeland Security (DHS) in 2006, telecom equipment companies were already facing heat from Chinese competition.

At DHS we saw the national security interest in protecting North American companies such as Nortel and Lucent. But we also knew that the fragmented U.S. and European industry couldn’t survive without consolidation. So when Alcatel of France offered to buy Lucent, we swallowed our pride and okayed the deal, fearing the alternative for Lucent was bankruptcy — the path that Nortel was forced to take just three years later.

We didn’t see eye to eye with France on national security, and we still don’t, but we were able to negotiate an arms’ length agreement that protected our security and ensured some continued capability in the U.S. and continued after Nokia’s acquisition of Alcatel-Lucent in 2015.

Fifth, fragmented industries are particularly vulnerable to government-backed competition. Right now, satellite telecommunications is highly decentralized and threatened by the new systems being launched by Musk and China. There are probably more than 50 active commercial satellite companies today, none with a market share over 15 percent. These companies will soon face Lucent’s choice: consolidate or die.

Sixth, making industrial policy on strictly national lines will not be enough this time around. The U.S. can’t have an industrial policy on semiconductors that doesn’t include Taiwan and South Korea. Its industrial policy on artificial intelligence will depend heavily on cooperation from the UK. Its machine tool policy will need help from Germany and Japan, just as its space policy has long been tied to Europe’s.

Western governments today are as fragmented as our most vulnerable industries. But to meet the challenge of China’s national champions, the West will have to embrace consolidation and scale, even if the price is prestige and local headquarters and learning to live with sometimes balky allies.

Because, as we could all soon learn, the alternative is worse. 

Stewart Baker has served as general counsel of the National Security Agency and assistant secretary for policy in the Department of Homeland Security. In his law practice he has advised a variety of companies, from chipmakers to satellite and terrestrial telecommunications companies. In 2021, as a member of the Homeland Security Advisory Council, he helped lead the drafting of a detailed report on supply chain security and industrial policy.