Democracies Must Coordinate Industrial Policies to Rebuild Economic Security

The United States can control its technological future only by working with other liberal democracies to reduce shared risks and vulnerabilities.

Russia’s invasion of Ukraine has created a watershed moment for the world’s leading liberal democracies. Perhaps most striking is the degree to which the invasion has renewed cooperation among democracies to address a shared challenge to their military and economic security. Their response demonstrates that these allies can mount a coordinated and rapid response to a shared threat. But will this translate into an ability to work together to address other pressing challenges—in particular, their economic, technological, and geopolitical vulnerability to China?

The rapidly growing concern over “techno-nationalism,” “technological sovereignty,” and “research security” reflects the fact that geopolitical jockeying and economic competition are increasingly focused on emerging and extant advanced technologies. These concerns are also evidence that liberal democracies with market economies—the United States among them—are struggling to come to grips with how to control their linked technological and economic futures.

Over the past decade, many liberal democracies have become aware of their growing economic links with China, considering that country’s role as both a huge market for exports and a global leader in manufacturing capability and related innovation. Further, as China’s economy and science and technology capabilities have grown, it has rolled out ambitious industrial policies to develop specific areas of advanced technology. Such moves fuel concerns about dependence on China for critical dual-use technologies (those with both military and commercial applications) such as artificial intelligence (AI), as well as for dual-use advanced technology components including semiconductors, smart communications equipment, and next-generation batteries.

In the wake of Russia’s invasion, liberal democracies have quickly and clearly demonstrated their ability to act in concert when they share interests. But what collaborations with other democracies will limit the shared and common risks of technological dependence on geopolitical competitors such as China?

Two critical policy shifts

First, US policymakers, along with those from other liberal democracies, need to recognize that China’s market size and rapidly growing R&D and innovation capability can only be matched if they work together. Democracies with regulated market economies, basic freedoms, and the rule of law need to expand beyond collaboration in basic science to engage in problem-focused, precompetitive R&D and later-stage applications of new scientific and engineering knowledge.

What collaborations with other democracies will limit the shared and common risks of technological dependence on geopolitical competitors such as China?

Given the dominant role of private companies in the science and technology (S&T) enterprise of liberal democracies, there is no way to reach adequate scale and scope unless fair and enforceable sovereign-to-sovereign R&D alliances and collaborations encourage and support applied R&D collaboration among private companies headquartered in different democratic nations. This is the case in domains of knowledge and application as diverse as AI, orbital space development, future wireless (6G), and alternative aviation fuels. Without immediate moves to reach global scale and scope in applied research through cross-border collaborations that leverage the private sector, there is a growing risk that the liberal democracies will be outmatched by China in critical sectors and dual use technologies.

Second, since liberal democracies depend heavily on private companies for most R&D, most innovation, and virtually all delivery of tech-intensive goods and services, the governments of these nations need to promote cross-border alignment and cooperation among their mostly private national innovation systems. They also need to develop and implement shared approaches to managing the risks and vulnerabilities of trade, cross-border investment, and advanced technology exchange and collaboration with geopolitical competitors such as China. This will require substantial work, of course, within each nation and in negotiating cross-border agreements and policies with each other.

Without immediate moves to reach global scale and scope in applied research through cross-border collaborations that leverage the private sector, there is a growing risk that the liberal democracies will be outmatched by China in critical sectors and dual use technologies.

In the immediate post-Cold War period, there was a belief that global free trade agreements—organized via the World Trade Organization—could knit together the market activities of all nations. That approach has not lived up to its promise. All nations “work the edges” of agreements to serve their own interests; but in China, state influence over companies goes further. In recent years, the Chinese Communist Party (CCP) has increasingly used approaches such as placing party units within firms, adding the pursuit of national geopolitical goals to corporate profit-making missions. International competitors cannot trust that Chinese firms’ market motives exist separate from their obligations to CCP political goals, and they cannot be sure that the Chinese government will not put its thumb on the scales of competition by changing the rules to favor Chinese companies. Therefore, the market-based R&D and innovation systems operating within and among the liberal democracies need to be working together and aligned and in dealing with nations that do not maintain regulated free-market economies.

The goal of making these two policy shifts in the United States—still the world’s largest investor in S&T—is not just to compete economically, but also to encourage other democratic nations to act together to retain adequate technological independence from China and other potential competitors. In most liberal democracies, and in the United States in particular, this requires substantial political will to make domestic changes and some particularly heavy lifting in international S&T policy and in reconfiguring economic relationships with democratic allies.

Companies and global competence in innovation

Appreciating the need for these shifts requires understanding the unique role private businesses play in the S&T enterprise in liberal democracies. US businesses spend over three times as much as the US federal government on R&D. Even more importantly, the nation relies on private enterprise for innovation. Companies execute virtually all development, design, process engineering, and scale-up necessary to create a commercial product or service (“from lab to fab” or “code to download”).

The market-based R&D and innovation systems operating within and among the liberal democracies need to be working together and aligned and in dealing with nations that do not maintain regulated free-market economies.

The decline of US dominance in global R&D is not because the United States has fallen behind but because the rest of the world has gained ground. US public and private investment in R&D is now about 30% of the global total, down from 69% in 1960. Similarly, starting around 30 years ago, there has been much greater global dispersion of the engineering and innovation capabilities that translate new knowledge into commercially viable products and services. And over the same period, intracompany and intercompany activities of MNCs—including supply chains, corporate partnerships, and joint ventures—have become almost wholly internationalized. The explosion in cross-border activity applies not only to those large organizations traditionally called multinational corporations, but also to technology-focused start-ups and smaller businesses that can today find suppliers or markets as easily in Europe or Asia as in the United States. This change has been both deep and wide and by now is deeply entrenched; private company cross-border R&D, design, and production activities have created knowledge networks and innovation ecosystems that span the globe.

The result of these long-term trends is that corporations now operate in, and take advantage of, a world of global competence in R&D, design, scale-up, and production, resulting in unparalleled choices as to how to organize their business on an international level. This abundance of choice, coupled with internet access, means that cross-border economic and military capability spillovers from private and public R&D are now the norm. An AI start-up, seeded by basic research funded by the US National Science Foundation and spun out from Stanford University, may look for programming talent in Asia or Europe and set up operations there. The same may be true in reverse for an AI spinout from Cambridge University in the United Kingdom seeking talent in Boston, Palo Alto, or Munich. An academic paper published online by a professor at Berkeley may be read instantaneously in Berlin and Beijing.

New concerns and a silver lining

Corporations now operate in, and take advantage of, a world of global competence in R&D, design, scale-up, and production, resulting in unparalleled choices as to how to organize their business on an international level.

These changes are forcing shifts in the long-standing attitudes of government toward the overseas activities of private industry. Thirty years ago, just after the end of the Cold War, the US government was hardly concerned when a US multinational set up a commercial R&D facility in China, the United Kingdom, Germany, or Russia. The same was true when US companies created complex cross-border supply chains, obtained or sold advanced technology components overseas, or set up manufacturing facilities in other nations. As long as US companies complied with international treaties and justified their actions in terms of commercial and shareholder interests, the US government regarded US companies’ overseas market activities—even in non-free market countries—as serving US national interests. The main exceptions have been activities that involve products and services related to defense and national security. In those cases, the US government has used export controls and investment controls managed by the interagency Committee on Foreign Investment in the United States (CFIUS), to restrict the actions of private companies. The situation is quite different today, when there is growing awareness that overseas activity by US companies may be inadvertently creating significant technological, economic, and military security risks for the nation.

This set of concerns—along with necessary US government action to address the risks—may be a hard pill for many US big tech companies to swallow. The largest tech companies in the world, including Apple, Microsoft, Alphabet (Google), Meta (Facebook), and Amazon, either did not exist or were in their infancy when the Cold War ended. None of them would have emerged and thrived without one or more forms of public support, from research and education funding at universities to government contracts, grants, loans, and procurement. While the issue of technological vulnerabilities with China has been simmering, these companies are now, with the Russian invasion of Ukraine, getting their first taste of the kinds of constraints the US government can apply to cross-border activity during a period of geopolitical confrontation.

There is a silver lining here for both US S&T policy and US companies. Just as geopolitical concerns may motivate increased scrutiny of the interface of market and nonmarket systems, they also provide a powerful incentive to strengthen regulatory alignment and increase market-based, tech-oriented collaboration among liberal democracies. Of the 20 most R&D-intensive nations, 19 are liberal democracies with market systems broadly similar to that in the United States; China is the one exception. Nine of the world’s 10 largest economies by gross domestic product are liberal democracies, again with China as an outlier. The aggregated population of those nine countries (a very rough measure of market size in the largest liberal economies) is, thanks to India, about 2.2 billion as of 2020.

There is growing awareness that overseas activity by US companies may be inadvertently creating significant technological, economic, and military security risks for the nation.

And, of course, a large number of liberal democracies are among the richest countries in the world; the G7 nations, European Union members, and other developed liberal democracies in Asia such as South Korea and Singapore have very high per capita GDP, three to five times higher than that of China or Russia. Companies operating within and among liberal democracies will find scale and scope—in markets, applied R&D capability, and production capacity—almost surely exceeding those of China and its allies.

To secure the US technological future, and that of our political and economic allies, two new policy tracks are urgently needed: first, cross-border, applied R&D and innovation collaborations; and second, economic and security policies that support collaboration with other liberal democracies to limit the risks and vulnerabilities arising from potential technological dependence on geopolitical competitors.

New applied cross-border R&D collaborations

Cross-border applied R&D joint ventures and collaborations are common in the private sector but rare in US sovereign-to-sovereign relations. This is not surprising, as they require co-investment by companies in the United States and allied nations and the creation of workable cross-border alignments in laws and regulatory approaches.

This type of working relationship is manifest both in the Biden administration’s approach to semiconductor supply chain resilience and in the historic activity of SEMATECH in the semiconductor industry decades ago. Public-private collaboration, combined with engagement of allied nations and non-US multinational corporations, is somewhat familiar ground in traditional US defense industries (and NATO, for that matter), but it needs to become the norm across the wide range of modern industries that can be passively or actively “weaponized” by geopolitical competitors in full-scale hot wars or low-grade confrontations. This range includes industries such as social media and cloud-based services, uses of orbital space, health products and services, climate change mitigation and adaptation, intelligent systems, food production and distribution, and advanced manufacturing. In the same way that today’s semiconductor or supply chain security problems cannot be solved with purely domestic actions, it is impossible to secure the United States’ future in a multitude of commercial but also security-critical industries without cross-border collaboration in applied R&D and innovation.

It is impossible to secure the United States’ future in a multitude of commercial but also security-critical industries without cross-border collaboration in applied R&D and innovation.

The US government lacks the organized institutionalized capacity to lead or even to follow in these types of activities. While the United States has well-developed models for cross-border investment agreements, and free trade norms and practices have been worked out in detail and are negotiated by the US trade representative, S&T agreements and cross-border investments are often left to individual agencies or the Department of State and tend to be heavily biased toward collaboration in basic science or relatively pure public goods (such as seismic information or weather data). Periodic episodes of White House-coordinated activity (such as the semiconductor plan or critical supply chain resilience) are not adequate. There is a need for a US government agency with the budget and capacity to lead a sustained intragovernmental coordination and funding mission in cross-border applied R&D.

Meeting this need requires an operation larger than a single program but smaller than a sweeping bureaucracy: something scaled at least initially between ARPA-E’s $500 million 2022 budget request and DARPA’s $3.5 billion annual budget (managed by 100 program managers). The new agency, like the Office of the United States Trade Representative, will need institutionalized external consultative processes. It is particularly important that this new entity be able to identify, bring forward, and vet cross-border R&D and innovation needs that arise from industry and to tap the large and diverse community of researchers in US universities and nonprofit labs. Its challenge in intragovernmental coordination will be to use its budget to catalyze and target increased cross-border activities by research funding agencies such as the National Science Foundation (NSF) and National Institutes of Health (NIH), as well as mission-oriented research activities in the Departments of Energy and Defense, the National Institute of Standards and Technology, and other agencies.

There is also an important legislative step that would allow agencies such as NSF and NIH to allocate increased funds to cross-border collaborative research. Similarly, the legislative and executive branches will need to review, and may need to revise, antitrust laws and guidelines to avoid chilling important cross-border precompetitive R&D collaboration.

There is a need for a US government agency with the budget and capacity to lead a sustained intragovernmental coordination and funding mission in cross-border applied R&D.

The EU has already moved in the direction of industry-engaged cross-border R&D collaboration through efforts such as Eureka and, more recently, the Important Projects of Common European Interest (IPCEIs). Eighteen countries and the European Commission launched Eureka in 1985. Now expanded to 48 countries in and outside Europe (South Korea, for example, is a member, but not Japan or the United States), Eureka blends public funding from government sources with industry interest in R&D projects designed to “support international industry-led R&D.” IPCEIs, for their part, are less about R&D than innovation and the entire supply chain for critical sectors. A microelectronics IPCEI was launched in 2018. A two-part IPCEI focused on batteries was established in 2019 and has received two tranches of funding totaling €6.1 billion for a “research and innovation project along the entire battery value chain.” A health IPCEI was announced in March 2022, emphasizing the importance of pharmaceutical manufacturing and innovation to address such issues as antibiotic resistance, future pandemics, and gene and cell therapies.

The motivation for Eureka was arguably to pool European resources to match the scale of R&D investment in the United States and Japan. IPCEIs represent a new form of cross-border industrial strategy—with heavy industry involvement—focused on innovative production processes for products with high research and innovation content. Neither Eureka (which is often said to be bureaucratic and political in its allocations) nor IPCEIs may be models for US engagement with other liberal democracies. And, of course, the European Union has a leg up in this type of cross-border activity as its members have already committed to considerable policy and trade alignment.

US dominance in R&D has waned and many other nations have developed deep production capacity in advanced technology products and components. Simply to keep up in commercial and dual use innovation the United States needs to move quickly to develop and join with other liberal democracies in cross-border applied R&D programs that leverage the wide range of emerging and extant advanced technology capabilities in industry.

Limiting risks and vulnerabilities

The second major shift needed involves economic and S&T policy changes that can limit US vulnerability to China in a wide range of dual-use advanced technologies. The challenge here is not doing something that has rarely been done before—indeed, nations have long protected their technological competitive edge for both military and commercial purposes. Rather, it is using existing logic and mechanisms, along with some new ones. The economic policy challenge is to maintain competitive markets among political and economic allies, even while working together to reduce the shared risk of dependence on technology and innovation from strategic competitors.

The United States needs to move quickly to develop and join with other liberal democracies in cross-border applied R&D programs that leverage the wide range of emerging and extant advanced technology capabilities in industry.

The United States has a long-standing resistance to industrial policy—to government selection of the “technologies of the future” or the promotion of national champions. This resistance has been bolstered by the tremendous success of US companies in S&T generally and tech-based US multinational corporations in particular. But the last decade has seen a slow erosion of such skepticism as politicians and policymakers have become aware that the lack of US industrial policy gives other nations some leverage to shape market outcomes, both globally and in the United States. Supply chain disruptions caused by the COVID-19 pandemic and concerns about a lack of domestic semiconductor production have only heightened the sense that government must—in an era of rising geopolitical tension—play a more active role in shaping the economy for economic and military security. Although national security is not the traditional justification for industrial policy, industrial policy ideas that would have been dismissed in 2010 are now widely seen as necessary to preserve national economic and military security.

Because of the role of private companies in the health and global integration of the US tech enterprise, this second policy track inevitably entails more government scrutiny of companies’ cross-border, technology-intensive actions. But what should oversight of those actions look like in practice? The logic of export control—share with allies, not with adversaries—has already taken hold in the US political process. The House of Representatives version of the America COMPETES Act, currently in reconciliation with an alternate version from the Senate, includes a provision to create an interagency Committee on National Critical Capabilities that, among other responsibilities, would selectively review and regulate outbound investment. Its focus would be parallel to CFIUS, which has a brief to review and, as necessary, halt inbound investment for national security purposes.

Though implementation details are still undefined, this new committee’s review process would introduce scrutiny of overseas activity. Does, for example, a private company opening an R&D laboratory in an authoritarian country inadvertently create a problematic military or commercial advantage for that country? Or is there a material national security risk if the supply chain for an advanced technology product—a medical device or an advanced material—depends on components from, or processing in, China? Given that complex supply chains are now the norm for technologically sophisticated products and services, this oversight process will be difficult, but this proposal is not a wild idea added to legislation by a small group of radicals; it is lifted directly from recommendations accompanying the 2021 Annual Report to Congress of the US-China Economic and Security Review Commission.

Is there a material national security risk if the supply chain for an advanced technology product—a medical device or an advanced material—depends on components from, or processing in, China?

These ideas were given new force when US export controls—foreign direct product rules (FDPRs)—became a centerpiece of US sanctions on Russia for invading Ukraine. FDPRs are aimed at shutting off Russia’s ability to purchase both US advanced technology products and products made elsewhere using US advanced technology such as design or control software. This was the same powerful and far-reaching tool used by the United States to temporarily hobble Huawei, the Chinese telecom company, for alleged unfair practices.

Whether the America COMPETES Act—almost certain to be passed in some form—includes a Committee on National Critical Capabilities is uncertain. This is likely only the first salvo in a barrage of proposals aimed at managing cross-border vulnerabilities and risks arising as an inadvertent consequence of the actions of private companies in R&D, innovation, or production. In the United States, a new generation of international economic policy proposals will almost certainly include, in some form, both incentives for onshore activity and regulations preventing the offshoring of certain types of economic activity and new tech applications to countries that do not meet established standards of the rule of law and free markets as well as reciprocity and national treatment in international dealings.

The immediate US policy challenge lies in building a less crisis-driven capacity to work with allies to identify and act on areas of geopolitical vulnerability and risk. The key concern will be how the activities of mostly private companies shape national technological competencies and vulnerabilities. Some necessary policy changes will be amenable to existing export and cross-border investment control approaches, whereas others will require new mechanisms and incentives to shift private R&D as well as production and innovation activities to the US and other market economies. Global supply chains and the global dispersion and network character of both “lab to fab” and R&D capability, mean that any policy effort of this sort will be meaningless if it is not pursued in close collaboration with a substantial majority of the leading technology-intensive liberal democracies.

This is likely only the first salvo in a barrage of proposals aimed at managing cross-border vulnerabilities and risks arising as an inadvertent consequence of the actions of private companies in R&D, innovation, or production.

Finally, it is important to recognize that the US research university community is a critical aspect of the US advanced technology enterprise and is enmeshed with both US and foreign tech companies, especially in engineering and applied sciences. The new generation of international economic policies and practices will need to address the differences between curiosity-driven research (openly published in the service of humankind) and research and innovation that—for military or commercial purposes—may require barriers to some knowledge flows between liberal democracies and nonmarket economies.

Collaborative policy for a shared challenge

The escalating economic, geopolitical, and technological competition between free-market liberal democracies and China is changing the worldview of US policymakers, companies, and citizens. The powerful economic and national security logic of free trade is still a very important guide for US economic and S&T policy. There is, however, a clear need for policies designed to limit risks arising from dependence on geopolitical competitors that do not meet basic standards of free and fair markets or of reciprocity and national treatment in trade, investment, and R&D collaboration.

Fortunately, the world’s leading democracies do meet those standards. By working together on cross-border economic and S&T policy, they can materially improve economic and military security in the twenty-first century. Indeed, it is only by working together that they can do so.

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Cite this Article

Guile, Bruce R., Stephen Johnson, David Teece, and Laura D. Tyson. “Democracies Must Coordinate Industrial Policies to Rebuild Economic Security.” Issues in Science and Technology (April 14, 2022).