Global Monopoly: Should it be a goal for National Innovation Policy; at what cost?
In short, choose early and choose wisely.
In part, globalization is rooted in the idea of comparative advantage. Nations should trade because some are more uniquely suited to production of certain goods than others. At the end of the trade, both nations benefit with a cheaper product. Not long into globalization, countries realized that sector dominance could be bought with targeted R&D in the sector to advance the country’s private sector and workers ahead of the international state of the art. China, for instance, now includes its targeted dominant industries in its public five year plans — their 2025 industries include biotech, AI, and unmanned aircraft. This strategy, however, has existed ever since the royal/national merchant franchises of the 1600s.
Many point to the Boeing and Airbus duopoly over the world passenger aircraft market as a current example of bought industry dominance. True, Boeing and Airbus are heavily subsidized by their respective governments, but aircraft manufacturing is a niche example that does not translate well to industries with lower cost of entry. Likewise, aircraft manufacturing is unique in that the operator pool is small and training for new planes is expensive (the key element to the 787 MAX scandal). So this industry likely could only support a handful of manufacturers anyway.
A similar, better example would be national airlines which are subsidized to dominate the air travel in and out of the country, albeit with a national pride element. Most of these national airlines require constant subsidies and in smaller countries they are often nationalized so the subsidy is directly to a loss-making enterprise. Some countries may benefit by being able to subsidize or even ensure access for tourists to their countries which ultimately raises their GDP and tax base. Other national airlines such as Swissair, Sabena, and most recently Air Italy, did not provide this benefit and/or their governments did not see the purpose in bailing them out and they were allowed to go defunct. Most of these airline failures were in Europe where access and tourism do not depend on a particular airline — in contrast to Tajik Air, for instance, of Tajikstan.
For competitive industries like airlines, the benefit to the country must be made on the back end via taxes on the new business lines created. This benefit is not one that particularly involves innovation policy, but these types of subsidy arrangements need to be highlighted so they are not considered together with innovation dominance like that in Chinese policy. Thus, constant national subsidies must be in place for many competitive sectors unless a natural dominance is established. This natural dominance, however, is also costly as we will see later.
A less competitive (or higher margin anyway) sector is pharmaceuticals. Like many sectors, a private entity can succeed in pharma via volume or via effectiveness/quality. The national strategy for India is to attain dominance by volume and export to the BRICS. That success has yet to be seen, though they do export low-cost medicine to Africa. In contrast, the United States has achieved dominance in the effectiveness or cutting edge portion of the sector. This dominance has been long lasting and has existed at least since the early 1900s. Early on, government subsidies for vaccination programs (e.g. polio and measles) certainly helped build manufacturing capacity and a skilled worker base.
Since that time, the US has maintained dominance by increasingly being the largest consumer base willing or capable of paying for cutting edge drugs. As we noted in a prior article on the US entertainment industry dominance, having the largest consumer base for a product can act as an export subsidy on its own (i.e. profit taking is mostly at home). Today the US spends a larger percentage of its GDP on health than any other OECD country. That is not necessarily a good statistic, but it does indicate the level of subsidy being sourced from the general populace. The US public pays the cost in higher medicare taxes and higher insurance premiums. As a result, most drug innovation, biologics innovation, and medical device innovation are conducted in the US where they can expect the largest market.
How then do countries like China target sectors for domination? Well one thing is for certain, the industries chosen are not random. Previously, China has seized on its natural advantage in lithium production to dominate green energy with low cost batteries and solar panels. They seem to have since moved away from extensive subsidies of this industry. So certainly, natural advantages play a role, but then that is the premise of comparative advantage.
China seems to have chosen biotech because it has already built a dominance in chemical intermediate manufacturing, a fact that came into focus when sourcing drugs post-COVID. From this solid foundation, China only needs to build out testing labs and educate a workforce of lab technicians and innovative lab directors. That roadmap seems to be working quite well if the sophistication of the Wuhan lab is any indicator.
Likewise, AI builds on their vast natural resource of consumer data that rivals that in the US. Furthermore, AI simply adds algorithm innovation to an already competitive software development sector in China. For more on China’s AI plan, Kai-Fu Lee’s book on the subject or any of the interviews with him will cover China’s plans in detail. My opinion is that no country or company does actual AI—advanced data mining is not AI. That is besides the point though, because there’s plenty of money in data mining dominance, which is what China, Google, Facebook, and the NSA are really targeting.
Finally, China’s choice of unmanned aircraft seems to be a national security choice, based on a national defense plan based on electronic warfare, drones, and submarines. Nevertheless, as the US vs Russian space race proved, what may start as a national defense dominance, can quickly translate into a decades-long duopoly on access to space. Furthermore, AI ties in closely with unmanned aircraft so there will be synergies there.
Working off China’s very public national targeting program, we can get an idea of how countries can subsidize an industry sector into dominance to expand its export market. We can also get an idea of how to chose such an industry. First, as with all innovation, it helps to have quality building blocks available locally (e.g. chemical intermediates or volumes of data). Second, unlike corporate innovation and dominance where second or third movers have advantages, in the national sphere dominance much like a monopoly is best done early. Early leads in expertise, low cost labor, training programs, and manufacturing capabilities are difficult to overcome later simply on a volume/scale basis. As a result, China is targeting nascent industry sectors that lend themselves to export and contribute to the national defense. Win-win. The United States has long employed similar tactics, and for example, just announced a similar defense-funded AI R&D initiative for the private sector.
The other considerations that go into choosing a sector for national dominance are the same ones that would be considered when building a monopoly: (1) Is there a narrow/domestic consumer base that can fund global expansion? (2) Is a long-term advantage attainable through investment (e.g. expertise building) or is the only advantage via cost cutting (e.g. airline economics)? (3) Is the product rapidly and universally exportable like chemicals or software (i.e. speed of market capture)? (4) Does the technological barrier to entry ensure lasting dominance if achieved? (5) Are there network effects that raise switching costs and can hold other countries hostage (e.g. Facebook vs Ireland)?
Then of course the country has to maintain a consistent policy and funding regime and have the money to play to win. But given all that, any country could be off to the races to establish their own global trade monopoly. In the end, though, the game is very costly but certainly winnable. Then again, winning can mean long-term outsized GDP expenditure on that sector (e.g. US pharma).