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Adam Posen: U.S.-China Decoupling: America's Zero-Sum Economics Doesn't Add Up



Industrial policy and subsidies are nothing new and can be useful. But shutting off from the world will have consequences. Beginning with the Trump administration, and accelerating under the Biden administration, U.S. trade and industrial policy has prioritized relocating manufacturing production back to the United States. For all their differences, both administrations disregarded other countries in this pursuit. Both also attacked international trade and investment as harmful to U.S. economic and national security, even though the rules for that very system were established by the United States and serve its interests. Along with members of Congress from both parties, the Biden administration has sought to take away production from others in a zero-sum way–explicitly from China and a bit more courteously from others.

Beginning with the Trump administration, and accelerating under the Biden administration, U.S. trade and industrial policy has prioritized relocating manufacturing production back to the United States. For all their differences, both administrations disregarded other countries in this pursuit. Both also attacked international trade and investment as harmful to U.S. economic and national security, even though the rules for that very system were established by the United States and serve its interests. Along with members of Congress from both parties, the Biden administration has sought to take away production from others in a zero-sum way–explicitly from China and a bit more courteously from others.

This policy approach, while having considerable popular appeal at home, is based on four profound analytic fallacies: that self-dealing is smart; that self-sufficiency is attainable; that more subsidies are better; and that local production is what matters. Each of these assumptions is contradicted by more than two centuries of well-researched history of foreign economic policies and their effects. Neither the real but exaggerated threat from China nor the seeming differences of today's technology from past innovations change underlying realities.

Industrial policy–government subsidies and protections to promote domestic capacity in a favorite sector–is nothing new in U.S. or global economic history, and it can be useful. The Biden administration's renewed push for public investment in infrastructure, research, and innovation is welcome, if oversold in its direct employment benefits. Targeted export and investment controls on China, Russia, and other military rivals on a limited number of well-defined high-tech goods could also be sustainable and worth the economic cost. But the protection and promotion of U.S.-located manufacturing against foreign competition is not only unnecessary for industrial policy's success–it will defeat the worthy purpose of it.

There is no question that many Chinese policies, including economic ones, are aggressive. They pose a threat to China's immediate neighbors, to U.S. national security, and more broadly to human rights and democratic sovereignty. But the extent to which China poses a direct threat to U.S. economic security is overblown. This is especially true since commerce with China yields significant benefits, Beijing is no longer massively undervaluing its currency against the dollar, and many of its supposedly self-serving, even cheating, tactics in trade have backfired. For example, subsidizing steel until it reached vast overcapacity has been a sinkhole rather than a success for China, contributing to environmental degradation and helping to ensure an uncompetitive workforce.

Nonetheless, those involved in U.S. economic policymaking face two difficult questions: First, what parts of the economic relationship are fueling Chinese military aggressiveness, either in capacity or intent? And second, what economic as opposed to diplomatic or military tools would be effective in stymieing Chinese threats to U.S. security? After all, further economic decoupling from China will have costs: not just to consumers and businesses but to U.S. military and intelligence capabilities. These include losing access to Chinese technologies that the U.S. military can benefit from and forgoing intelligence derived from commercial engagement with Chinese companies. Additionally, Washington would have meaningfully fewer resources to spend on defense and information-gathering because everything the United States acquired abroad would be more expensive, including capital to finance part of government debt.

A unilateral U.S. withdrawal from commerce with China would be partially offset by other economies taking up market share where the United States no longer operated. If anything, it would increase the arbitrage opportunities for other countries and for companies headquartered elsewhere to trade and invest where the United States ceased to do so.

What will not address these threats–and what, in fact, will backfire–are U.S. attempts to impose arbitrary export and investment restrictions on China that extend to other countries. In order for such restrictions to succeed, the United States would have to become a commercial police state on an unprecedented scale. The United States would also have to monitor and prevent its own headquartered companies from moving activities abroad. Washington has done this, on a limited scale, on specific technology transfers. But scale matters, and current proposals would be an order of magnitude more ambitious and thus infeasible. Besides, U.S. industrial policy should encourage the widespread adoption of the best technologies at home and abroad rather than favoring localized domestic production, which only limits the spread of technology.

In big-league sports, the best job is to be league commissioner. You can ultimately decide the big questions of how the game is played.

Aggressive behavior from Beijing is instead best confronted by diplomacy and defense capabilities. Washington may feel frustrated with the lack of quick wins here, but that is no reason to take that frustration out on the rest of the world–let alone on private Chinese companies that happen to have had commercial success. In fact, doing so will make U.S. security worse by hindering the technological progress necessary for resilience and by eroding the United States' influence on third countries.

Compare this approach to what was for a long time the status quo: the United States as creator and enforcer of international economic rules, not visibly and directly picking who was in or out in a given industry. The United States benefited from acting within the system to constrain countries' specific behaviors rather than publicly judging their general nature. It could even occasionally flout the rules, or tweak them in its favor, if it didn't overdo it. Most of all, though, leading a rules-based system allowed maximum economic traction while minimizing the need for direct conflict.

An economic and trade strategy that calls out individual countries, complete with tit-for-tat retaliation for perceived or actual slights, throws this all away. Instead, the United States becomes just another player in the game, with no justification for its self-dealing and no reason to stay on its good side beyond one-off transactions. That transactional view, in turn, defeats the goal of reordering the economic system, whether to limit China's military power or speed up adoption of green technologies.

Additionally, if the United States and Europe agree to discriminatory manufacturing subsidies, and only China can afford to compete, it tells the rest of the world that their aspirations for development do not matter: Only those in the lead now will be allowed to scale the heights of technological production. This would mean that countries in the developing world would have to go cap in hand, government to government, to get access to one nation-state's products–let alone be a part of the production process. The ability of individual companies in developing economies to earn investment on merit would be sharply diminished. That would disincentivize growth and breed justified resentment.

In big-league sports, the best job is to be league commissioner. As commissioner, you make money whichever team wins or loses on a given day, you are welcome at every stadium (even if occasionally booed), and you can ultimately decide the big questions of how the game is played and who is allowed to own a team. If you instead become identified with a single team, sometimes you win, sometimes you lose, but most importantly, others have an interest in your losing. You might even get repeatedly punished for cheating, instead of being the one to decide who is cheating. And when it comes to another issue in the news–supply chains–the tendency to join a side rather than oversee it all is equally shortsighted.

The idea of "Buy American" has broad populist appeal. It connotes an economy that is self- sufficient, producing all it needs, and "putting American workers first." Yet detailed research has repeatedly shown that policies aimed at maximizing domestic manufacturing employment rather than the development and adoption of new technologies are not only doomed to fail but crowd out the very industrial and trade policies that contribute the most to innovation, national security, and decarbonization.

Recent supply problems contributed to the Biden and Trump administrations' proposals to invest in local production. But as scary as a shortage of semiconductors has been, it is truly the exception that proves the rule. In reality, market economies adapt quickly to shortages; dominant suppliers almost never boycott selling to customers. Also true is that shortfalls in supply are much better addressed through trade and, in the case of some technologies, the stockpiling of strategic reserves.

Take the European Union's response to stoppages in oil and gas supplies after Russia's invasion of Ukraine. Eurozone economies adapted to higher and more volatile energy prices far more rapidly than most expected. Prices even dropped after European economies stopped demanding so much supply. The same has been true at every juncture when there has been an interruption in supply or when energy exports have been withheld; in 1973, after a Saudi-led oil embargo, Western economies shifted production and consumption patterns within a couple of years.

Yes, a supplier of a critical commodity with malevolent intent can cause pain via temporary shortages, but an effective response is to stockpile strategic reserves and turn to trade with other places.

Meanwhile, Russia did not get anything terribly useful in diplomatic terms when it tried to weaponize Europe's dependence on its oil and gas. When Russian President Vladimir Putin cut off gas from the Nord Stream 1 pipeline in mid-2022, he induced Germany and other European economies to reduce their dependence on Russia while strengthening Europe's support for Ukraine. His dominant supply position did not even prevent the EU from encouraging Ukraine to turn its way in recent years. And despite Putin's threats to cut off global supplies, Russia has up to the present day continued to keep oil and gas exports flowing to other buyers.

Buy American policies actually cost jobs.

In other words: In an actual war situation, with a most malevolent supplier making seemingly credible threats, Europe has not been deterred or even swayed. This shows that market economies' resilience is much greater, and the ability of suppliers to extract concessions much less, than the scaremongering used to justify extreme U.S. industrial policy would suggest.

Investing in productive capacity tied to jobs in specific localities is misguided for two reasons. First, it does not create new jobs; it merely shifts jobs from one place to another. To create jobs in one place, a handpicked publicly subsidized investment has to draw the workers with the relevant skills from other U.S. employers, unless those workers come via immigration increases or are sitting idle and willing to move. More immigration would certainly be desirable for this and a host of other reasons, but it is extremely unlikely in today's political climate. As for idle workers with the right skills, they don't really exist. Currently, the U.S. industrial economy has a vast excess of job vacancies relative to the number of available workers, with notable shortages in the kinds of employees needed for the production of semiconductor chips and their components.

Furthermore, Buy American policies actually cost jobs. When the United States imposes Buy American requirements on government procurement, or restrictive "rules of origin" or local content requirements on imports, these requirements have three effects. First, they simply raise the costs of any government purchases undertaken, thereby reducing the amount of bang U.S. taxpayers get for their investment buck. Second, they cost U.S. sales in foreign markets. And third, they erode the competitiveness of U.S. goods by making exports too expensive. As is becoming apparent with the high, restrictive domestic content requirements of the 2020 United States-Mexico-Canada Agreement, there are ever fewer cars produced for export in North America. Meanwhile, there is more investment by U.S.-headquartered auto companies in China to reach that market. But what of the race for subsidies for green tech production? As desirable as it is to have the United States move forward on green tech, starting a subsidies contest with the EU is misguided, too.

By , the president of the Peterson Institute for International Economics.

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Posted: March 24, 2023 Friday 06:00 AM