Laura D'Andrea Tyson's appointment to chair the Council of Economic Advisers received savage treatment from some of her professional colleagues. According to Peter Passell of the New York Times, "jaws dropped" in academe at the announcement. Passell went on to describe Tyson as "trendy" and a "polemicist." And the addition of Princeton's Alan Blinder to the Tyson council found MIT's Paul Krugman celebrating, in print and for attribution, that Blinder would bring to the CEA "necessary analytical skills that Laura Tyson lacks."
Is there a serious issue behind these attacks? Trade policy, of course, or so they say. One trade economist suggested to the Times that the Council was now to be "captured by an interest group." William Cline of the Institute for International Economics complained of the exclusion of free traders: "There's a risk a voice will be absent from the table." And Passell summarized the views of others: "Many worry that her lack of ideological commitment to free trade will open the gates to protectionists."
But this explanation is problematic, as readers of Who's Bashing Whom: Trade Conflict in High Technology Industries will discover. Tyson is not a protectionist. She is neither polemical nor trendy. Her work reflects the modern mainstream in trade theory and its changes over the past 20 years. But she is not a model-builder and evidently does not believe in drawing sweeping conclusions for policy by the method of deduction from first principles. She is, instead, a nuanced observer of the world as it actually is, a collector and weigher of evidence, a student of details. And it is this characteristic, alongside the policy differences to which it leads, that appears to be the root of Tyson's difficulties with her brethren.
Tyson is careful. She defines her subject with precision: not all trade conflicts but only those in high technology and therefore, virtually by definition, between the U.S., Japan, and Europe. She notes that in these areas the notion of a principled or ideological commitment to free trade is already a minority view. She describes the actual mainstream as a broad middle ground, which she calls the "moderate free trade" position, in which a preference for free trade is tempered by acknowledgment that markets are imperfect and that externalities and strategic behavior exist. She notes that this new middle position already provides a range of justifications for government interventions in both the domestic economy and the regime of world trade.
Tyson pays tribute to the work of theorists, such as Krugman, who ironically prepared the ground for this new consensus by questioning the case for an "ideological commitment to free trade" built on the bedrock principle of comparative advantage. This view had held that specialization and free trade were the right policies for any country, irrespective of what its competitors did. Tariffs are financed by one's own consumers; subsidies are transferee (through lower prices) to one's customers abroad. Thus confronted with dumping, say, of computers by the Japanese, the correct response is not quotas, tariffs, or countervailing subsidies of domestic firms, but the advice said to have been offered by a top economist in the Bush administration: "Where can I get some?"
Krugman has shown that this is not necessarily smart. His work incorporates imperfect competition and increasing returns to scale into trade models. If an industry has declining costs, then excess returns may be earned by that producer who enters first and moves to the high-volume, low-cost position. The country that moves first into a new field with these characteristics wins. Technology policies can help private producers make the move. The country with the best R&D establishment and most flexible capital market may also be expected by its competitors to enjoy repeated successes in new technologies, and this (along with, perhaps, a few object lessons like the recent Japanese failures in fifth-generation computing and high-definition television) may deter them even from attempting to compete. In these ways, Krugman's own development has taken him toward justification on theoretical grounds of a limited industrial policy.
But Krugman has not abandoned free trade. He fears, along with the whole professional establishment, that when it comes to trade, the government will fail to follow through. Even if the correct principles for applying subsidies and protection are scrupulously respected, government is unlikely to do the calculations correctly. Worse, the correct principles themselves will be quickly forgotten. Worse still, and somewhat special to trade policy, our application of subsidies and protection may generate retaliation, and an uncontrollable slide toward autarky and trade war. Free trade is not necessarily the best outcome, but it is the only simple rallying point around which policymakers can be made to agree. Krugman has written: "To establish a blanket policy of free trade, with exceptions granted only under extreme pressure, may not be the optimal policy according to the theory but may be the best policy that the country is likely to get."
Laura Tyson disagrees for two reasons. First, where the mainstream now believes that industrial development policies may or may not do some good, Tyson believes they are indispensable. Second, where the mainstream still shies from risking anything with trade policy, Tyson believes that government policies can improve on market outcomes.
Tyson marks her departure on the first point with something quite bold:
Although I could easily hide behind the moderate free trade disguises described here, it would be disingenuous for me to do so. Unlike most free traders, unilateral and moderate alike, I believe that what we as a nation make and what we trade matter. ... Technology-intensive industries, in particular, make a special contribution to the long-term health of the American economy. A dollar's worth of shoes may have the same effect on the trade balance as a dollar's worth of computers. But...the two do not have the same effect on employment, wages, labor skills, productivity and research--all major determinants of our long-term economic health.
In other words, she endorses the view, advanced several years ago by her Berkeley colleagues John Zysman and Stephen Cohen, that "manufacturing matters." There exist feedbacks and cumulative benefits, in the form of new knowledge and human and physical capital formation, from certain kinds of advanced industrial activity. Since the benefits of these feedbacks do not accrue solely and strictly to private investors, these activities as a class will be underprovided in a free market. Government sponsorship of advanced industrial activity is ipso facto desirable.
But then again, Tyson is careful:
Even economists who might be persuaded that high-technology industries make special contributions to national economic welfare are likely to remain highly skeptical about the ability of the American government to intervene effectively on their behalf...Because I share many of [these] reservations, my recommendations for trade and domestic policy are self-consciously cautious.
"Cautious activism" is thus the order of the day. Having thus characterized herself and her framework, Tyson turns to a chapter of foundation-building and four case studies. The foundations are the evidence that there do exist spillovers and excess returns in advanced technology. Tyson notes the fact that these industries account for 60 percent of industrial R&D, even though only 20 percent of output, and she cites studies indicating that industrial R&D has a large excess of social over private returns. She points to the high proportion of scientific and technical personnel in these industries, and to their high and rising relative wage rates --evidence that workers in advanced technology are able to command supercompetitive rates of pay. And she closes with a brief discussion of national security concerns.
Nothing here goes beyond what is widely accepted by professional economists, and one may puzzle at the strong reactions these arguments appear to evoke. There is, however, a critical question of emphasis. Those who hide behind the cover of "moderate free trade" freely acknowledge that externalities and imperfect competition exist, but then tend to downplay their importance in the larger scheme of things. Government interference, too, is viewed as an evil whether necessary or otherwise, one which policy should minimize rather than manage. In the end, moderate free traders shrink from allowing these "market failures" to govern policy outcomes. For Tyson, in an analytical tradition that recalls Joan Robinson as well as Joseph Schumpeter, externalities, monopolies, and government interference must be regarded as the irreducible facts of the game. This focus emerges most clearly in her cases.
The cases in her book cover (1) market access for U.S. high technology in Japan, (2) U.S.-Japan trade in semiconductors, (3) the Airbus challenge, and (4) European industrial and trade policies in electronics. All of the studies are complex, detailed, institutional, and historical. Their common thread is that trade in high technology is already managed, al-most everywhere in the advanced world, and that advanced-technology companies have a pattern of relationships with their governments that neither should nor can be broken, as the free traders would like, by trade agreements. High technology is integral to the development strategies that most advanced countries pursue (including the U.S., though Tyson does not dwell on the American case). The real issue in high-technology trade conflict, therefore, is not "managed" versus "free" trade, but the appropriate policy for the United States in a world of managed trade.
In other words, Tyson's cases have persuaded her that free trade is often a chimerical goal, doomed to be thwarted in one way if not another. And, she believes, government can do better by recognizing as much and by confronting those who would manage their markets with an equal, sophisticated, and determined strategy for getting part of the deal. Well-designed trade policies amount, in her view, to bilateral management of outcomes that would otherwise be, not free, but unilaterally managed--by the other side. Tyson is not prepared to take on faith that foreign (say, Japanese) manipulation of trade is always and everywhere, as orthodoxy would have one believe, against Japanese national interest. And she is prepared to argue the empirical point that in fact it is possible for the U.S. to develop and implement an intelligent, selective approach to trade intervention that improves the equity, and even in some ways and cases the efficiency, of the outcome. Since this is an empirical point, Tyson's book is suited to her method.
One of its simpler and most luminous tales concerns the efforts of Motorola to sell cellular telephones in Japan. Motorola had invented cellular phones and in the middle 1980s had the most compact and advanced product on the market. However, its efforts to sell phones in Japan ran into licensing restrictions that restricted Motorola's phones to the western half of the country and only 30 to 40 percent of the market. Motorola's phones could not be used in the Tokyo-Nagoya region, whereas those of NTT, the principal Japanese competitor, could be used anywhere in the country. The ostensible reason for this arrangement was a shortage of radio frequencies in the high-density region.
Motorola complained, and received the backing of American trade officials. A Super-301 retaliation was threatened. The result: "In June 1990 [the Japanese government] finally agreed to reallocate frequencies to allow Motorola to compete in the Tokyo-Nagoya region. [This] decision revealed what Motorola had argued all along--that there was no technical barrier to this outcome." Motorola was effectively dealt a place in the Japanese market, and its sales of cellular telephones started to rise. Japanese consumers and American producers both benefited; here was a clear case where bilaterally managed trade produced a result superior to the unilaterally managed alternative.
The 1986 Semiconductor Trade Agreement (STA) with Japan provides Tyson with perhaps her toughest case, since as she says "the conventional wisdom among economists is that the STA was an unmitigated failure." Tyson argues for a "more nuanced conclusion." On the negative side, she finds that the antidumping provisions of the STA had distinctly anticompetitive effects on Japanese DRAM (memory chip) producers, leading them to collude on a price floor that benefited all Japanese producers at their customers' expense. A similar outcome occurred more recently (in July 1991) when antidumping tariffs were levied against Japanese active-matrix liquid-crystal displays, forcing American computer manufacturers who use those displays to consider relocating offshore. Countervailing subsidies from the U.S. to its own producers would have been much better policy in both cases; unfortunately Reaganism (and later Bushism) ruled that out.
On the other hand, the provisions of the STA aimed at securing greater access for American producers to Japanese markets apparently worked: Japanese purchases of foreign semiconductors increases, and the "increase was largely the result of concerted action by the Japanese semiconductor companies themselves to realize a 20 percent foreign share [the STA target] in their own purchases." In the end, Tyson writes, "the U.S. share of the global DRAM market stabilized; the precipitous decline in the U.S. share of the global EPROM market was reversed; and the share of American and other foreign companies in the Japanese market reached new highs."
It is hard to derive general policy rules from the complex facts of these cases. For example, in the STA case, Tyson argues that the market access provisions probably could not have been obtained without the pressure of what proved, in the end, to be a counterproductive antidumping suit. The issue in this case cannot therefore be divided into good and bad parts but must be decided on whether the whole package was to be preferred to the non-interventionist (and therefore unilaterally manipulated) outcome. In other cases that trade-off may not be present, and the issue will be framed in some different way.
Yet there are patterns here. On analytical grounds, Tyson is leery of traditional protectionist measures, such as antidumping actions and voluntary export restraints. She is especially open to market access measures (or "voluntary import expansions" as some economists call them), and makes a principled analytical as well as empirical argument that these can improve on unilaterally-manipulated market outcomes. And she advocates a coherent domestic industrial policy, particularly where a consciously planned policy might improve on a haphazard or misguided or excessively militarized de facto policy, as in the long history and present case of airframes.
Circumstances and technologies and the relevant laws and policies all vary, and vary enormously, but in the end a coherent message does emerge from the welter of detail in this book. Advanced technology trade is already managed. Like it or not, we are caught in a struggle to maintain our share of the spillovers that advanced technologies produce. This will require facing up to the whole panoply of neglected and abused public responsibilities: from public investment, education and training through targeted support for industrial and commercial research and development, to the management of high-technology trade. It will require doing so at a very high level of case-specific analytical expertise, something which our government has often been blocked by ideologists from acquiring. If we fail to understand this struggle, and to work on it at the level of technical, legal and diplomatic sophistication that these studies reveal to be necessary, we will find our industrial mix shifting against us in ways that will cause our future living standards to decline. Tyson concludes, "given the certainty of continued policy intervention abroad, [we] can no longer afford the soothing but largely irrelevant position that market forces alone should determine industry outcomes in the future."
Ultimately, it is the complexity of the world that Tyson confronts, and the powers of synthesis she brings to her work, that best explain her professional and political problems. In establishing that the devils of appropriate trade and industrial policies are truly in the details, she threatens with irrelevance not only the "free market" but also a whole class of professional economists whose totemization of the market has provided them a ready-made policy platform. What will these people do, if their all-purpose formulas are no longer sufficient? Maybe the old boys really are threatened by this appointment.