Trade relations with China appear to be converging on an agreement that will bring more US exports - particularly farm products - to China. This will reduce the trade deficit between the US and China. Is this the best way for the US to respond to the rise of China?
China’s economic performance over the past 40 years has been nothing short of miraculous. In 1978, when Deng Xiao-ping became chairman of the Chinese Communist Party, or CCP, China’s GDP was about $150 billion in constant US dollars, according to the World Bank. Last year, 40 years after the transformation Deng initiated in China, its GDP in constant US dollars had soared to over $13 trillion dollars, a rate of growth of roughly 10% a year. In recent years, this growth rate has slowed to around 6%, but the overall rise of China’s economy has been simply astonishing. Meanwhile, the US growth rate is seemingly stuck around 2 to 3 percent a year, making it only a matter of time before China’s economy becomes larger than that of the US.
How should the US respond to this enormous rise of its economic rival? The first thing to observe is that the US has seen other nations rise up dramatically before. Those of us of a certain age can vividly recall the rise of Japan, from being occupied by the US after losing to the US in World War II, to achieving economic leadership in many of the leading industries of the twentieth century forty years later. These industries included electronics, machine tools, automobiles, semiconductors, steel, and chemicals. Observers like Ezra Vogel wrote best-selling books with the title, “Japan as Number 1”.
How did the US respond? Many people in the US in the 1980s were deeply fearful of a world in which technology leadership would be lost to Japan. This prompted some soul-searching and a lot of hard work on the part of the US and its companies to address some serious issues they had, issues that were impairing the ability of the US to be as innovative as its rival. This work proved to be productive. While Japan remains one of the largest, richest economies in the world, its technological capabilities no longer inspire the same degree of fear in the US. And Japan’s economy remains much smaller than that of the US. Earlier, in the 1960s and 1970s, many worried about being overtaken by the Soviet Union, particularly after the launch of Sputnik in 1957. By 1991, however, the Soviet system collapsed.
There is an important lesson for us from these earlier episodes, a lesson that informs how the US might best deal with the rise of China. That lesson is that the US works best when it uses the rise of a serious rival to re-invest in its own innovation infrastructure. Our innovation infrastructure consists of the hard and soft assets in the society to generate, disseminate, and absorb new innovative knowledge. This requires investments in hard assets, like 5G connectivity or up-to-date airports, roads and train stations, as well as investments in soft assets, like training, skills, universities and other forms of human capital development. The infrastructure starts with public investment, which in turn attracts a larger amount of private investment, which culminates in greater innovation capability for the whole society. A strong innovation infrastructure can promote greater growth, while a weak or aging infrastructure reduces the growth of the economy.
After the launch of Sputnik, the US launched a number of initiatives to strengthen its scientific capabilities, from the Apollo moon program to DARPA and the expansion of federal funding for university research. When Japan threatened, the US responded by improving its product quality in a number of industries, and also strengthened its entrepreneurial spirit by allowing pension funds to invest in venture capital, reducing the capital gains tax rate, and expanding entrepreneurial education. Indeed, the US never recaptured leadership in the specific industries that Japan had come to dominate. Instead, the US invented new industries that became more valuable than the earlier industries that were overtaken by the Japanese.
With China’s rise, we have another opportunity to address some of our own internal weaknesses and limitations, in order to respond effectively to the new competition we face. Our science base and our innovation infrastructure need another renewal, as large US companies have cut back on basic research, and effectively have outsourced this to our universities. This impairs their ability to develop new breakthrough technologies, and to absorb the breakthroughs of others. Our universities, in turn, need to open up more, so that more of their output is shared more widely throughout the society.
Our workforce training also is woefully in need of a rethink. People are graduating college with debts of $50,000 or $100,000, armed with degrees that do not allow them to find gainful employment beyond being a barista at Starbucks. We are lacking in science, technology, engineering and mathematics (STEM) graduates, and shackling our social science graduates with too much debt at the very beginning of their careers. (This student debt, by the way, cannot be discharged even in bankruptcy under current law.) Companies are also contributing to the training problem, by eliminating the kinds of training, rotational programs and internships for newly hired workers that they used to provide.
This approach requires us to go far beyond trade policy in dealing with China. Today the public discussion of responding to China has largely been confined to US tariffs on Chinese goods and boosting US exports to China. Much, much more is needed. The US would do well to harness the challenge that China poses, and use that challenge renew its own innovation infrastructure. We compete better when we use a perceived rival to bring out the best in ourselves.
