As we slide into a Holiday week here in the US, another in a series of columns I have written over the last two years on "Saving Western Manufacturing?," where I have pondered both whether manufacturing in the US and other developed markets can be saved, and then if yes, whether it really should it be.

This week, I start with an anecdote. When I was in grad school in the late 1980s, I had one professor who constantly spoke of the greatness of Japan's "Industrial Policy." How could we possibly compete with Japan, he said, when they have all these very smart people steering economic and manufacturing policy decisions, while the US has this rather rudderless chaos of a free market, or something close to it. To a pretty green MBA student having come into the program from another discipline, it seemed a convincing argument.

I know I am now sounding old, but you have to put that discussion in the context of the times. Despite a strong period of economic growth during the 1980s in the US, the country seemed to be losing ground to a surging Japan and its industrial policy. The visible signs here included Japanese companies buying US real estate with all their money, from the Pebble Beach golf course to Manhattan skyscrapers. US public resentment was strong.

The apparent change in fortunes was nicely brought into relief in a late 1980s article and then book co-authored by Sony founder and then chairman Akio Morito - The Japan that Can Say No. It wasn't translated to English until 1991, but summaries had reached US shores long before. This was Japan feelings its oats in a big way, highly critical of the US in many areas, and confidently boasting it could now stop being a "Yes man" for US policies.

Morita concluded, according to a Wikipedia entry that:

• American business focuses too much on money games like mergers and acquisitions, and not enough on creating real goods and manufacturing power.
• American business focuses too much on short-term profits, such as moving manufacturing overseas, while sacrificing long term overall livelihood.
• Employees in Japanese companies form a tight community, so overall results are better.
• The trade surplus with the U.S. is caused by the lack of desirable products made in the US.
• US. businesses are strong in basic research, but not in product development and marketing
• It is natural for the Japanese government to protect Japanese businesses, as it relies on their tax revenue.

 Sound familiar to maybe the US and China's situation today?

There was only one big problem back then - shortly thereafter, Japan's economy imploded. The "lost 1990s" was a decade-long recession that left the country economically weak, and from which it really has still only partially recovered. By contrast, of course, US economic growth in the 1990s was robust, leaving Japan far behind.

It turned out, in fact, that Japan's Industrial Policy makers weren't so smart after all, and that the interlocking connections between Japanese businesses may have promoted collaboration but also led to a lack of competition that resulted in stagnation and a weak cost and product innovation. Industrial policy indeed. The idea was discredited here in the US and much of Europe. What my old professor would have said about that I have no idea.

Which brings us to 2010, and China. In its strange mix of capitalism and authoritarianism, has China battered US and Western manufacturing, seen years of double-digit type economic growth that has it on a path to overtake even US GDP before too long, and a strategic intent around specific industries and commodities that seems to be a real winner. Has China dramatically improved the Industrial Policy model?

In the US and Europe, the focus of this economic threat has been over the value of the Chinese Yuan, which many believe to be undervalued, but that's just the most convenient touch point in the crucible of debate about the role of manufacturing in developed economies and the huge issues of unemployment and job creation.

"Since the end of the Cold War, the world's powers have generally agreed on the wisdom of letting market competition—more than government planning—shape economic outcomes. China's national economic strategy is disrupting that consensus," wrote the Wall Street in an article this week.

It cites the example of the solar panel industry, where a few years ago a key raw material - polycrystalline silicon - was in short supply, with prices rising 1000%,  and its sources dominated by Western producers. Those rapidly rising costs were being passed on to China's nascent solar panel manufacturers.

The Chinese government took swift action. Development of domestic polysilicon supplies was declared a national priority. Money poured in to manufacturers from state-owned companies and banks; local governments expedited approvals for new plants. While in the West it might take many years for the right approvals and then plant construction, one Chinese entrepreneur got his plant up and running in just 15 months - with funding from the Chinese government that left it with a 20% stake in Poly Energy Holding Ltd.

Problem solved.

The Wall Street Journal had this to say: "China's national economic strategy is detailed and multifaceted, and it is challenging the U.S. and other powers on a number of fronts."

That is putting it mildly. The Journal c alls China's approach "state capitalism," a sort of economic strategy never really seen before. Central to this approach are policies that "champion state-owned firms and other so-called national champions, seek aggressively to obtain advanced technology, and manage its exchange rate to benefit exporters." China also leverages state control of the financial system to channel low-cost capital to domestic industries—and to resource-rich foreign nations whose oil and minerals China needs.

This is the amazing thing to me: while most developed economies and governments are heavily constrained by the bureaucracy and perceived government inefficiency, in China "It's a model with a track record of getting things done," the Journal writes - though of course China does not need to worry much about environmental impact studies, personal property rights, or any of those inconvenient factors Western companies and governments must navigate to get things done.

And it is an approach in which it is not the least bit hesitant to use a heavy hand. We reported a couple of times on China's stated intent now turning to reality to hoard its near monopoly production of "rare earth" metals that are key to high tech and other products.

As we reported a few weeks ago, China's Ministry of Industry and Information Technology is developing plans that would force foreign car makers to turn over advanced technology for building electric cars and batteries as a precondition getting access to the potentially vast Chinese market.

Just this week, it was reported in the business press that - what a surprise - the early "partnerships" Western train makers had with Chinese companies are now having those relationships turn against them. The erstwhile partners of the West have now adopted their technology and are aggressively competing against their former partners for China's exploding high speed rail market with an new generation of technology building on what they learned from Western firms.

Understandably addicted to the potential for growth in China's huge and rapidly growing market, for the most part Western companies begrudgingly play along, even if ultimately to their doom.

In 2006, China published its "National Medium and Long-Term Plan for the Development of Science and Technology," a blueprint for turning China into a tech powerhouse by 2020 and ridding itself of dependence on foreign technology. Microsoft, Cisco, et al - I would be concerned. Just recently, China unveiled the world's fastest supercomputer.

"The Chinese have shown that if they have the ability to kill your model and take your profits, they will," says Ian Bremmer, author of a new book that says Western nations need to dramatically rethink their approaches.

Some predict that this approach will ultimately fail, as state-run industrial policy did in Japan. Prominent Chinese economist Qian Yingyi told the Wall Street Journal that he worries over what appears to be "a reversal of market-oriented reforms in the last couple of years," and that the growing role of government everywhere there could backfire.

I indeed think it can and will backfire. Long term, market forces to me clearly are better than central government planning can ever be. But in the long term, we're all dead.  

The question is whether Western manufacturing will also be dead before the weaknesses of the Chinese approach really manifest themselves. "State Capitalism" would lose the war ultimately, but it is cleaning up on the battlefield right now.

Can the West compete for now with the State Capitalism model of China? Is some sort of Western Industrial policy needed? If not that, what can be done for Western manufacturers? Let us know your thoughts at the Feedback button below.

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