Breaking China’s Hold

The United States is in danger of missing a profound change in the economic component of China’s geopolitical strategy. Chinese President Xi Jinping has downgraded the Communist Party’s ambition to overtake the U.S. in economic size (though that is still officially a goal). Instead, his priority is to minimize China’s dependence on other countries and maximize its ability to coerce them economically. This is an implicit acknowledgment that China can’t achieve the aim of being a truly rich nation anytime soon. But the U.S. cannot afford to be complacent: China can wield its very large economy as a strategic weapon.

Just as the U.S. previously needed to respond to a China that was bent on becoming the world’s foremost economy, Washington now needs to respond to a China bent on long-term economic coercion to secure the interests of the Communist party and the Chinese nation. Domestic action by the U.S. is important, and is easier to achieve, starting with better understanding Xi’s goals. Internationally, to persuade friends and allies to limit their reliance on China, the U.S. must revive a moribund trade policy.

Xi clarified China’s new approach in a series of speeches in 2020, claiming that the “powerful gravitational field” of the state-controlled Chinese market can be used to reshape supply chains in Beijing’s favor. In Xi’s view, this is essential in what he’s called the “great struggle” against Western efforts to limit China’s technological advancement and target its import vulnerabilities.

China has, of course, long engaged in industrial espionage and coercive technology transfer. And Xi’s “Made in China 2025” industrial plan has, since 2015, provided sweeping government assistance to such sectors as semiconductors and electric vehicles. Xi now seems to believe that China must redouble efforts to tilt economic leverage in its favor, as Beijing responds to what it views as an evolving American strategy of containment. Xi may see the decoupling of the two countries’ economies as ultimately inevitable—and may now be actively advancing it, on his preferred terms.

At home, Xi evidently fears that a thriving private sector risks powerful constituencies developing outside party control—he has cracked down on activities perceived as threatening in this respect. With the party determined to retain control of the economy, potentially productive industries face many barriers to expansion. In their place are sectors that serve the party’s interests first. This is not conducive to innovation and scientific breakthrough and, along with deteriorating demographics and high debt, will continue to limit growth.

This hardly means that China has given up on competing with the U.S. and others, but it will do so through state-shaped technological development and, crucially, its preeminent position in global supply chains. China will be neither the world’s low-tech factory nor its leading tech pioneer, but will aim instead to make itself indispensable as a producer of high-value goods upon which even its adversaries depend. This is a perceptive and potentially fruitful alternative to rapid economic growth.

Regarding electric vehicles, for instance, China owns substantial overseas reserves of lithium and cobalt and is rushing to add more. It also seeks to become the premier processor for these minerals. Green-energy equipment may be made elsewhere, but it will rely on Chinese materials. In biopharma, China dominates the production and export of basic pharmaceutical ingredients and is looking to expand final manufacturing of pharmaceuticals.

In aerospace, Airbus, Boeing, and Bombardier will soon face a Chinese competitor, COMAC, whose planes look a lot like theirs. If the Chinese planes improve, the foreign firms will have more trouble selling theirs to China. Then COMAC will start exporting on a large scale, beginning with poorer countries. For semiconductors, the PRC has a strong position in testing and packaging at the end of the supply chain. It seeks to greatly expand the production of low-end chips. Without a better defense against Chinese oversupply, foreign competitors will be killed off, and China could dominate major parts of the industry.

If this proves to be the new order, the U.S. and a few other countries will remain richer than China, and their industries will make big breakthroughs, such as in mRNA vaccines and high-end microchips. Beijing will continue to largely absorb foreign innovation and then eventually drive foreign producers out of business. The dominant feature of the Sino-American commercial competition will not be a race based on economic growth or on technological advancement, as many anticipate. Rather, through subsidies, coercive technology transfer, and unbalanced market access, inferior Chinese firms will win market share at the expense of more dynamic competitors.

China will still seek growth, just not as its main priority. It will spend heavily on science and technology. But its focus will be on strategic economic leverage. Beijing’s theory of victory in this clash is that its combination of strategic planning, manufacturing prowess, and a huge market will undermine foreign innovation, insulate the party from American pressure, and arm Beijing with more tools of economic coercion. This could also force more deindustrialization in the U.S.

If American policy makers and the private sector want to avoid this fate, considerable decoupling must occur. The U.S. will need to revise its economic strategy or it will continue on a course toward asymmetric dependence on China. This must start with changes to the world’s wealthiest national economy. The low-cost consumption that Americans enjoy through trade with China will have to give way so that more reliable production is a priority. This will cause some short-term economic pain, but it is protection against China’s inevitable disruptions of future American consumption.

The coronavirus pandemic has already pushed the private sector in this direction. Government policy must now codify and amplify the shift. These policies cannot be pushed through by executive fiat; they require a bipartisan consensus and new or modified law.

Some production will need to leave China so the U.S. can exchange cheap goods for greater economic resilience. A new economic strategy will mix producing more in North America with importing goods from trustworthy trading partners. There is already bipartisan support for boosting production at home—the 2022 CHIPS and Science Act is the best example to date.

The international component of American strategy is more difficult because there is bipartisan support for protectionism as well. To tackle this problem, Washington should consider updating free-trade agreements, complex as that will be, after exploring narrower, sector-specific agreements for crucial supply chains and creating bilateral technology agreements. All of these measures should get congressional approval.

Bilateral technology agreements are relatively simple: Only a handful of countries matter in technology development, and the American goal should be only to limit transfer to China. America’s partners will be activated by their own national-security concerns, as well as worry over China’s record of copying technology, then driving out the original developers. But some of them will also have to free themselves from entrenched dependence on China, which will require time and consistent American policy to overcome.

Agreements covering particular industrial sectors can be useful, involving not only tech but others, such as pharmaceuticals, as well. The approach involves strictly enforcing limits on Chinese participation in a supply chain serving the U.S. This same enforcement creates opportunities for firms to make gains in the American market as the subsidized Chinese competition is blocked. Some partners, with their own concerns about Chinese participation in supply chains, may not need much incentive.

An administration and Congress—both motivated by unfair Chinese competition—should be able to agree on pursuing such negotiations under the Trade Promotion Authority, through which Congress gives the president negotiation instructions in exchange for an up-or-down vote on any deal. If this occurs, the next step is to make the case to partners to partly replace the role played by China’s large labor force; South Asian and Southeast Asian countries such as India, Indonesia, and the Philippines are well positioned to benefit.

How far and fast Xi’s new economic strategy will go is debatable, but some signs of coercive economics are already apparent. In 2017, China blocked consumer products, travel, and cultural trade with South Korea because it deployed a U.S. anti-missile system (aimed at North Korea). In 2020, Beijing restricted trade with Australia as punishment for Canberra’s desire to investigate COVID-19’s origins. In late 2021, China began boycotting Lithuanian goods in response to the Baltic nation’s establishing closer diplomatic ties with Taiwan. If unchallenged, China’s bid on supply chains will further shift patterns of production and trade in its favor.

China is creating more enterprises like Huawei in semiconductors, biotechnology, and other industries. At some point, if Washington does something Beijing dislikes, China may simply stop the supply of crucial goods in these sectors. The nature of China’s economic challenge has changed. America must adapt to meet it.