ALL POLITICS IS INDUSTRIAL — It’s the economic buzzword of the moment and one of most important concepts to grasp if you want to understand the trade wars of the 21st century: “Overcapacity.” The banality of the wonky economic term disguises its importance. It’s how the Biden administration explains its decision this month to raise tariffs on certain Chinese industries like electric vehicles and batteries. National Economic Advisor Lael Brainard gave a whole speech on the suddenly mainstream concept last week, saying Beijing has been “investing in significant industrial overcapacity” and is “flooding global markets with artificially cheap exports.” Treasury Secretary Janet Yellen brought it up again on Tuesday, when she called for G7 nations to present a “united front” against Chinese overcapacity. So what’s all the fuss about? It all goes back to industrial policies — similar to those that Biden himself is enacting in the United States today. The term overcapacity, as it’s used by policymakers, simply refers to a country producing more industrial output from a given sector than the market would usually dictate. Typically, it’s done through government subsidies — like China’s subsidies for electric vehicles that allow them to produce high-quality EVs for a fraction of the price of U.S. competitors. Why would a country want to over-produce certain goods? Because it wants key domestic industries to produce at a higher level than they would without government support. Say, for instance, competition from cheap foreign cars means that automakers in your country want to close down factories, or move them offshore. Offer those domestic automakers some subsidies, tax breaks, or other goodies that help them lower their costs, and maybe they can keep the plants open. “In order to resolve domestic employment problems, one of the things countries can do is implement certain [industrial] policies. They could be to depreciate the currency, raise tariffs, suppress wages – a number of different policies,” said economist Michael Pettis, who has written extensively on the topic. “They all have the same effect. What they do is they reduce domestic economic demand by forcing households to subsidize industry.” Those industrial policies can have some big political advantages. Keep those plants open and you can brag about saving industrial jobs, supporting industries key to national security, and beat up on foreign rivals at the same time — all familiar themes in our political discussions here and abroad. But those policies also have costs — largely, for other nations. If you’re a government subsidizing the domestic auto sector, for instance, you will be encouraging those factories to produce more cars while, at the same time, reducing your own consumers’ ability to buy them. “The problem with these policies,” said Pettis, “is that if you force households to subsidize manufacturing, they buy less stuff and manufacturers produce more stuff. And so then you run into the problem of what do you do with all of that stuff?” One option is to increase the spending power of your own consumers, so they can buy more cars. But that’s also expensive and brings other tricky politics into play — taxing and redistribution. An easier option is just to dump those products on another country. Then, you’re not only supporting a domestic industry at home, but helping it capture market share abroad. In practice, mostly the latter has occurred. As countries like China, Germany, Japan and others moved to support key industries over the past few decades, they have seen the U.S. — with relatively low tariffs and few industrial policies of its own — as a key market to dump that excess capacity. And as economic inequality has risen around the world – reducing the ability of citizens in each country to consume manufactured goods – the incentive for manufacturing-heavy nations to dump the goods on another market has only increased. In that way, domestic income inequality within individual countries has helped drive trade conflicts between countries, as Pettis and co-author Matthew Klein argued in their seminal 2020 book, Trade Wars Are Class Wars, which has become a central text for both Biden and Trump’s trade advisers. That dynamic is why some developed nations retain robust manufacturing sectors, while others have seen them wither away. “If you look around, you’ll see the manufacturing share [of the economy] in Japan, Germany, China, South Korea, Taiwan, etc. are all above the average, whereas the manufacturing share of England and the United States are below average,” Pettis said. “Manufacturing is simply responding to subsidies and going to where it’s most subsidized.” Responding to overcapacity — and its causes — can be seen as the key issue that both President Joe Biden and former President Donald Trump are trying to solve with their trade policies. For Trump, the solution is to try to negate the foreign subsidies at the border, through dramatically higher tariffs on allies and adversaries alike, along with potential actions to devalue the U.S. dollar, which would boost U.S. manufacturers. For Biden, it’s emulating the industrial policies of our rivals with domestic manufacturing policies of his own — namely the CHIPS Act and Inflation Reduction Act — along with more modest tariffs on key sectors like EVs. Whether any of those policies are enough to combat China’s massive subsidies remains to be seen. But matter who wins in November, expect the struggle against overcapacity — not just from China, but globally — to continue. Yellen already is trying to convince other nations to combat Chinese subsidies with tariffs and trade restrictions of their own, hoping to keep Western manufacturers afloat amid intense competition from Beijing’s state-led industries. And if Trump captures the White House, U.S. trade policies could be turned against some of those allies, as well as China. His former trade chief, Robert Lighthizer – in line for a senior economic role in a second Trump administration – has been clear that he sees overcapacity from allies like Germany as a threat to the U.S. economy, along with China. He writes in his 2023 book, No Trade is Free, that many U.S. trading partners “manipulate their currency, give subsidies to their manufacturers, and maintain extensive non-tariff barriers, such as discriminatory regulatory requirements,” which make “American producers less competitive in those markets.” Exactly how those policies manifest is still an open question. But one thing is clear to economists like Pettis: the era of free trade is done, and the era of industrial policy has begun. “There is definitely a major change taking place in the way Washington is starting to think about these issues,” he said. Welcome to POLITICO Nightly. Reach out with news, tips and ideas at nightly@politico.com. Or contact tonight’s author at gbade@politico.com or on X (formerly known as Twitter) at @GavinBade.
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