The Great Rivalry

           "Even a super power has limits"

                                                                                              ---Ariel Sharon


The Recent trade war with China has put the power rivalry between the United States and China in grand display. For the next decade and beyond, the two countries are destined on a path of power struggle between the number one super power and the ascending rival. This competition will involve multiple fronts and will continue long after the Trump presidency. That the Chinese have come to this juncture so quickly from such humble beginnings during the eighties is quite remarkable. What is the best path going forward for the United States and China?

If you were an Englishman in the twenties, looking across the pond to an ascendant United States, you would feel a similar sense of unease as we are feeling now in the United States regarding China. The United States did overtake Britain as the world's super power. So with the perfect hindsight, what could the British have done to prevent the rise of the United States? The answer is, not much. Short of war, the rise and fall of nations are largely due to factors internal to the country. Outside interference could perhaps slow the trajectory but not alter it. What is more, energy spent and the cost of fighting such a "war" could detract from our ability to solve our own internal problems.

The main areas that the two countries compete in includes economics, science and technology development, military, geopolitical and soft power projection. In the upcoming posts, I will look at each of these. For the remainder of the post, let's examine the economic aspect. In particular, how the economic trajectories of China will impact the power rivalry of the two nations.

Most people, having walked through the aisles of Walmart, have come to the conclusion that the way to stop the rise of China is to cut off their exports. This might have been true in 2006, when Chinese exports counted for a whopping 36% of China's GDP. Today, that number is 19% and dropping. The United States' share of the Chinese export is 19%. of that, a big portion (maybe a third) is export by the companies of the United States and allies, so cutting off this portion of the export will hurt companies like Apple way more then it hurts China. Another part of the export are goods that have no substitutes, or one can only find substitute at a huge mark up. For example, virtually all of the world's rare earth metals, which are crucial for many industries, including defense, came out of China. Even the American mines send their oxide to China to have it processed into metal. The portion of Chinese exports that could be taxed without badly hurting the U.S. defense, our companies or our lower and middle class consumers thus are much smaller portion of the total. In addition, their value added, or what the Chinese get to keep by this export, is a small fraction of the export value itself, since often times, they are the final assembler taking components from supply chain across the world. I remember a study done which said that the worst case scenario of the trade war was about a 1% impact on the Chinese GDP.

America's economic problem has to do with the lost of our industrial base. This actually preceded China's rise. I remember watching TV and saw people smashing Japanese cars in front of news crews in the eighties. Our highly inventive research and development came up with products, but were unable to profitably manufacture them in the United States. The causes are complicated. The biggest issue is the quality of our work force. High end manufacturing today is highly sophisticated, requiring huge amount of capital, know how and a highly intelligent, educated and disciplined work force. As America pushes into the more profitable sectors like tech and financial sectors, these sectors have also captured the lion share of the American intellectual elite. Other industries, which have lower profit margins, have been robbed of the talents needed to compete. The exodus of manufacturing would be slower if there were not a diligent work force on the other side of the pond ready to do the work, but the East Asian countries provided competition which pushed the bar higher. This sped up the decline of American manufacturing. The semiconductor industry is an example, Even as the design team stayed behind in the Bay Area and Austin, the manufacturing part has gone first to Japan, then South Korea and Taiwan and now China. Success in this industry is not about having cheap labor, but the ability to get to high efficiency production first. Otherwise the huge amount of capital will sit unproductive longer, causing the firm to fail. Having a high IQ work force that is willing to work day and night makes all the difference between success and failure. That is the reason why semiconductor manufacturing have gone to only East Asian countries. It has to do with the availability of a highly competent and disciplined work force willing to do what it takes to get the job done fast..

The financial industry also contributed to the decline of American manufacturing in two ways. First, they siphon out part of the profits of the other industries via financial engineering. Since banking and investment industry are well established, we would expect profitability to decline like other industries that are matured and highly competitive. This is, after all, the economic theory coming out of the economic classes in colleges. However, profitability of the financial sector is near the top among all the industries. Since financial sector touches all industries, we have to conclude that some of the profits from the other industries have been transferred to the financial industry through financial manipulation. Without the profit to sustain them, many industries have died off. The second way it contribute to the demise of the American industries is through the short term nature of how Wall Street reward our economic participants. If you are two years from retirement and running the company, You would care a lot more about the stock prices in the next two years versus will the company survive in ten. In that case, you would prioritize short term profitability over the longer term survivability of the company. GE, which used to be the model for the rest of the American companies, is a shadow of its former self due to this shortsightedness. Boeing, which had the recent debacle with their 737 Max, is another example.

So what is to be done about this? So some might say we tax the hell out of these products and bring back the industries. Unfortunately, Fortress America is not a solution to this problem. This is because the Europeans, who enjoy working less than the Americans, have tried the Fortress Europe idea and the result has not been good for the last couple of decades. There is no reason to believe that we will do better if we try the same thing. Others cling on the automation and 3D printing as the key to reversing the de-industrialization, but this is unlikely. More automation and 3D printing requires even more skilled and disciplined labor force, not less. Trump tried to deny ZTE chips from American companies, but eventually back out of that idea. Certainly it would badly hurt ZTE, but companies like Qualcom will also be badly hurt. What is more, this action have spur many Chinese companies to start making their own chips. A powerful Chinese chip industry will appear on the horizon a lot faster than it would be otherwise be.

The rise of the Chinese economic power is due to their ability to learn from the outside world and having a large scale manufacturing work force that is intelligent, disciplined and hard working. They have a large internal market to consume their own products.They trade with the entire world, most of whom will not sanction the trade since China is a large trading partner. Many countries would not be able to produce what China was producing and had to buy from somebody anyways. To them, the Chinese provided inexpensive and high quality products that otherwise would cost them a lot more. The most important of all, the government of China is very capable and able to get things moving along. Today, like America was in the 1920s, the fate of their economic rise is mostly in their own hands. Outsider can slightly slow but not stop their rise. Given that they still have lower per capita GDP and other indicators such as lower value added in their industries, lower robotic density per thousand worker etc, there is every reason to believe that they will in time get to the cutting edge in manufacturing. They will have their own aeronautic industry like Boeing and Air Bus. They will have a very large share of the chip designing and chip making industry. AI will also boost their productivity in the coming decades. There is no way to stop the rise of the Chinese economy. We should focus on improving our own. We can also try to benefit from China's rise.