EconoMonitor

Last Days of Rome

How America Builds Its Way Back to Balance

The following is an excerpt from The Reckoning: Debt, Democracy and the Future of American Power, with a forward by Dr. Nouriel Roubini, available in the United States on this week from Palgrave Macmillan and in Europe on 17 May. Moran, a former RGE vice president and geostrategy analyst, is now Director and Editor-in-Chief of Renaissance Insights, a new offering of thematic essays and events from the investment bank Renaissance Capital.

Back in 2007, before the bubble of faith-based US economic growth imploded, the surging vitality of China’s smokestack economy was already clear. “China Makes, the World Takes,” read the title of a perceptive article in the Atlantic magazine, a play on the now sadly inappropriate sign that welcomes motorists to the down-and-out nineteenth-century factory town of Trenton, New Jersey.

Like Trenton—and countless other American mill towns that helped bring the Industrial Revolution to the New World—China’s great manufacturing complexes now dominate global markets across vast product lines, including appliances, consumer electronics, and consumer durables like sporting goods, clothing, toys, furniture, and textiles.

Yet China lacks something that Trenton and its nineteenth-century peers had in spades: innovators. Charles Roebling, for instance, the son of the man who designed the Brooklyn Bridge, founded Roebling Steel in Trenton and perfected a machine that turned out the huge wire cable that made suspension bridges possible. (He also, incidentally, provided the steel for the first Slinky, ironically now produced in Taiwan.)

While China excels at building and even incrementally improving established product lines like GM’s Buicks and countless other Western and Japanese goods manufactured there, it has struggled to innovate. Even in 2010, the year China officially overtook Japan as the world’s second largest economy, no Chinese brand could viably be called a household name in any Asian market, let alone in the wider world.17 The annual global branding study by the market research firm TNS found in 2010 that, while consumer brands from Denmark, Finland, South Korea, and Switzerland make the top 20, no Chinese product or brand appeared in the top 1,000.

Eleven of the top 20 brands were American, including giants like Google, McDonald’s, Coca-Cola, and Facebook. Four were Japanese (led by Sony [number one], plus Panasonic, Honda, and Canon). Two more (Samsung and LG) hailed from South Korea. The two most famous Chinese inventors of the twentieth century—An Wang, the personal computer pioneer, and Flossie Wong-Staal, a scientist who helped identify the AIDS virus—both made their names in the United States.

Surely, a nation of 1.3 billion will produce brilliant designers, engineers, scientists, and other innovators in this century. Since 2000, for instance, Chinese researchers have created the smokeless cigarette (invented by pharmacist Hon Lik in 2002), a wind turbine driven by magnetic levitation technology (developed by Li Guokun in 2006), and the first quasi-ballistic long-range anti-ship missile, an invention of great concern to the US Navy.

Yet, while these are notable achievements, something is retarding China’s transition from copycat manufacturer to innovative top dog. The kind of manufacturing that accounts for nearly all of China’s export earnings relies on low-cost inputs, including labor, as opposed to the value-adds of quality and technology that underpin an advanced economy’s manufacturing sectors, notably in Japan, Germany, and the United States.

Annually, those export earnings—essentially the difference between what China pays to import products and what it earns on its exports—have gradually fed the growth of China’s best-known sovereign wealth fund, the China Investment Corporation (CIC), and a variety of state companies and policy banks that control the $3.2 trillion war chest of hard currency reserves.19 It is this money that purchases the sovereign debt of the United States and many other developed economies, along with copper mines in Peru; oil concessions in Angola, Sudan, and Iran; a dominant interest in the Panama Canal Authority; and stakes in US corporations, including a recent bid for a large chunk of Facebook. All of that, to many in the United States particularly, sounds nefarious.

Nowhere on the Chinese horizon are there purveyors of disruptive technologies on the scale of Apple, Microsoft, Germany’s SAP, or for that matter the collection of oil services and corporate giants that solved the problems associated with hydraulic fracturing. Writing off the United States as a post-industrial power tremendously undervalues the dynamic nature of its economy. Its worth noting that, nearly flat on its back since the Great Recession began, American corporations managed to earn record profits, retain or expand market share in may key regions and even introduce some potential world-beating products, including 3D printing, Apple’s iphone and iPad, Google’s “Cloud,” Facebook, Twitter and its empowering offshoots, plus a host of other breakthroughs from genomics to jet engines.

Technology holds out enormous promise for those in the emerging world who properly harness it – particularly those who view technology as a means of leaping over development stages once assumed to be necessary simply to move from the low- to middle-income grouping. Eastern Europe skipped the arduous process of replacing its antiquated telephone landlines after 1989 by going straight to mobile and satellite broadcasting. MENA and SSA countries have followed suit and improved on the trick – with Kenya leading a revolution in electronic banking and Qatar-based Al-Jazeera putting its western competitors to shame in the deployment of up to date digital technologies that pried open previously closed societies.

China’s progress in this regard is less impressive. The combination of a nineteenth-century business model and a twenty-first-century pseudo-communist political repression saddles China with disadvantages that make it tremendously vulnerable to small commercial disruptions with not only the United States but also the EU and Japan. This is not just about losing sales for Chinese products in those markets, but losing the designs, technologies, and techniques needed to produce them. The “import/assimilate/reinnovate” model, as economists refer to it, does not foster a climate of original innovation, according to a recent study of US and Chinese competitiveness by the Center for American Progress, a liberal US think tank.

The problem might be solved in the long term by investment in R&D and reforms to China’s economic incentives and education system—indeed, Japan suffered from precisely these problems early on in its emergence from the depths of destruction after World War II into a postwar economic powerhouse. But economists also suspect that the centralized nature of China’s government will prove a lasting liability, allowing the United States and other advanced economies to maintain their lead in high-tech goods for far longer than might otherwise be the case. While the ability to make clear decisions and adhere to plans decades in advance clearly has some advantages, it also stunts creativity and blunts the incentives a market economy creates for turning patents into viable commercial and technical breakthroughs that respond effectively to evolving consumer demands and complaints.

This underscores a deeper dilemma. China’s brute strength in manufacturing is based on the simple, and possibly unsustainable, deal that the Communist Party made with its urban elites—namely, that it will keep incomes rising and leave these urban elites alone to make money as long as they keep their political aspirations to themselves. But as more and more Chinese in the vast, poor interior clamor for their own piece of the pie, wages will rise and demands for safety and environmental codes will erode competitiveness. When this happens and jobless workers get angry, the urban elites may renege on the deal for a greater say in their own government. Even then, the rural millions may not have much patience left.

As its recent surge in patents shows, China is by no means doomed to remain a smokestack power. Increasing investment in science, technology, and other innovation sectors, now running at about 1.5 percent of the GDP, puts China at the top of the table among emerging economies in terms of R&D spending, and fourth overall behind only the United States, Japan, and Germany.

Put another way, China can claw its way up the value-added food chain and move its companies beyond the goal of building a better, cheaper Buick and into the high-end, high-margin markets for software, aerospace, robotics, and sophisticated engineering currently dominated by the United States, Europe, and Japan. But the progress to date has been almost impossible to measure, and the country’s substandard educational system, demographic and political challenges, and corruption suggest that this will be more of a Long March than a Great Leap Forward.

Follow me on Twitter or read my new book, “The Reckoning: Debt, Democracy and the Future of American Power.” 

15 Responses to “How America Builds Its Way Back to Balance”

Michael Moran BillyConnApril 11th, 2012 at 10:46 pm

Not entirely, a much more involved and realistic strategy to 'not lose' would be more accurate. Zero sum is not the right way to approach this question.

R. CoutinhoApril 12th, 2012 at 11:52 am

I am reminded of the Borg in Star Trek the Next Generation when reading about China. They seem to have the same limitations and nearly the same type of government (at least the Chinese gov't would seemingly LIKE to have it that way). There is no substitute for free thinking. If one suppresses free thinking in one area, it will spread to all of the areas.

Aegean1972April 12th, 2012 at 12:57 pm

i dont think the US will "let" China reach to that level of progress. To the "great leap fwd".

The change is already happening to shift the manufacturing power of china to other parts of the world. Because excess manufacturing money is what feeds the beast and pays for R&D which can create innovation and autonomy. I dont think the US wants an autonomous China.

China is a nation that not-too-long-ago (1989) was riding over its citizens with tanks…How can we trust such a nation with the worlds cash surpluses. It would be insane not to stop them.

Spread the manufacturing process to many "small, flexible and managable chinas". Indonesia, India, africa, middle east, latin america, balkans. Putting too much power in one nation is very risky. Spreading the money and growth to other parts of the world creates more stability and more jobs around the world.

Something tells me that in the next years China will styart having "internal" problems and social unrest…A new "chinese spring" maybe (from the arab "spring").

R. CoutinhoApril 12th, 2012 at 9:01 pm

If I have seen the data correctly, China is already experiencing "Chinese springs." They are chasing protests like whack-a-mole.

SaminApril 13th, 2012 at 2:44 pm

so what? China have enough reserves to live out a long time,

I think the ideology of the government is that they would rather give freedom to the people to R&D if it ever gets to the point that their manufacturing advantage will be threatened.
I believe they have enough reserves to find another way to retain an advantage or interdependence on them

marketfollowerApril 13th, 2012 at 4:20 pm

@Samin "China have enough reserves to live out a long time" As you say, so what? The reserves cannot be spent within China without putting a huge hole in the Bank of China's balance sheet. (See mpettis.com on this.) They can be used to buy foreign assets, but how does that help China build its innovative capacity?

mayur1205August 21st, 2012 at 6:34 am

Very informative article. Pretty sure people would love to go to that place for shopping. Specially to those who are semi naughty or semi conservative people. I guess there are a lot of things their that can be bought.
partybingo

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Ella BoulgerJune 15th, 2014 at 7:11 am

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