NO MORE POSITIVE ENGAGEMENT

For Lack of "Responsible Stakeholders."

Before I get into analysis I want to apologize to my readers for my long absence from the keyboard. I have had surgery and been hospitalized for the past six weeks as a result of gall bladder stones. I am still on the mend, but not yet out of the hospital. Fingers crossed for next week. Thanks for not forgetting me.

Whether they know it or not, recent speeches and actions by U.S. Treasury Secretary Janet Yellen, EU Commission President Ursula von der Leyen, U.S. National Security Advisor Jake Sullivan, South Korean President Yoon Suk Yeol, and Japanese Prime Minister Kishida Fumio have put past to the myths of “positive engagement”, unfettered free trade, global peace and comity through globalization, the evolution of a “flat world”, and former World Bank President Robert Zoellick’s much praised notion of China becoming “a responsible stakeholder in the liberal, rules- based system.” The fairy tale of “positive engagement” that began with the Nixon-Kissinger flirtation with Mao and Chou in 1972 and blossomed fully in the wake of the supposed end of the Cold War (indeed some said the “end history”) in 1991 and the advent of the Clinton administration has now been shown to have been just that - a fairy tale.

Yellen, especially, made the point that considerations of national security far outweigh those of private profit whether in the short or long term. Maintaining technological leadership in semiconductors she emphasized is far more important to America’s long term national economic and security interests than, say, the extra profit free world chip and chip equipment makers might gain today by selling advanced chips to China for use in things like hypersonic missiles or sophisticated face recognition devices.

Even more significantly, Yellen and Sullivan were effectively saying that any steps not taken in the past to protect and ensure U.S. semiconductor and technology leadership were mistakes of the most serious nature. In other words, what a country makes or doesn’t make really matters and is not always something that can be left to the chance whims of the global marketplace, where the mercantilist policies of other countries are very consciously being used to effect fundamental shifts in technological and strategic leadership away from the United States.

Of course, having been major players in the old Establishment, none of the speakers will fully embrace the mercantilist, managed trade/globalization doctrine they are effectively declaring. Thus, they speak of “de-risking” or of “friend-shoring” rather than of strategic trade, but there is no blinking what they are proposing. After all, if you don’t want China to have cutting edge semiconductors, you also cannot want it to have cutting edge artificial intelligence, or aerospace capabilities, or leadership in any other dual use products and technologies. You also cannot want it to have a lock on the production or supply of any product, technology, or service that has potential strategic significance.

Of similar importance is the tacit admission that what a country makes matters. This notion has been heresy among the professional economic elite for the past fifty year. That Janet Yellen, an economist’s economist, is saying it is important for America to make semiconductors is astounding, but credit her with having the courage to speak the truth, much better late than sorry.

Of course, if it is important for the U.S. to make cutting edge semiconductors, it must also be important for it to make many of the materials and components of semiconductors as well as a wide variety of other advanced and even mundane products. A glance at China’s list of the products it has formally aimed to have made in China by 2025 and 2031 would provide a good starting point for what must inevitably be a U.S. industrial policy.

Of course, what it might take to develop such a policy beyond a few subsidies for semiconductor manufacturing has so far been completely ignored by the likes of Yellan and the vast bulk of our economists and political leaders. However, a recent article in the Harvard Business Review, China’s Innovation Advantage by Zak Dychtwald, lights the path.

Dychtwald makes two fundamental points heretofore virtually unaddressed by U.S. analysts and leaders. He begins by noting that China in 1991 was not a manufacturing power. Indeed, it hardly manufactured at all. China’s leadership determined that wealth arose primarily from manufacturing and decided to build the country’s economy into a manufacturing driven economy no matter what it took. It protected a wide variety of industries with tariffs and restrictions on foreign investment. It heavily subsidized virtually all industries and further subsidized the export of much of this production.

Ask yourself if the United States ever adopted a similar policy. The answer is yes, on two very important occasions and more frequently in several other cases. The first instance was at the end of the War of 1812 when Jefferson finally yielded to Hamilton’s long expressed desire to build America into a major manufacturing country rather than into a land of yeoman farmers as Jefferson had been proposing. The war had nearly been lost because of lack of American manufacturing capability able to match that of Great Britain. Jefferson yielded elegantly by noting that “manufacturing is necessary to the Union and to our defense,” Thus, in 1815, America adopted high tariffs on imports and subsidized things like the development of the telegraph, the trans-continental railroad, the steel industry and much more. Washington maintained this policy of protection and subsidized industrial policy until the end of WWII. Like China today, America than determined that it would become a manufacturing power by hook or by crook.

At the beginning of WWII, America was producing virtually none of the weapons and other products necessary to fight a war. In the face of the war challenge, the U.S. government ran perhaps the greatest industrial policy the world has ever seen. It did not twiddle its thumbs about the dangers of government waste and inefficiency. Indeed, it made U.S. industry much more efficient than it had ever been because it made a firm decision to win no matter what.

JFK’s decision to send a man to the moon, was a flat- out industrial policy. A clear goal was set and woe to him who questioned or deviated from the chosen path.

It is this kind of approach that has turned China into the greatest manufacturing power of all time. China’s leaders don’t wring their hands about how and whether it can be done. They just decide to do it. There is no reason that the United States cannot do the same.

A second key element of the Dychtwald article is the point it makes about China having achieved rapid and increasingly sophisticated advances in manufacturing without a highly skilled, sophisticated work force. He emphasizes that Chinese workers have learned by doing and have made sophisticated advances in production by dint of highly honed shop floor skills and close coordination of the whole production chain. An experienced, dedicated, common work force thus becomes a hugely valuable asset that in important ways reduces the necessity for sophisticated R&D programs, and high visibility automated manufacturing factories. As Dychtwald says, '“it is not what you invent that counts, but what you make and how much you sell.

This thinking, of course, runs contrary to that of U.S. economists and business leaders who focus on short term wage savings and efficiency rather than on establishing a winning juggernaut for the long term. In their rush to cut costs, they have been throwing away the skills of their U.S. based work forces and thereby actually adding welfare costs to the U.S. economy while reducing its long term innovation and productivity potential.

A final foolish oversight of the conventional U.S. wisdom is that of simply ignoring some enormous real costs. Long, sophisticated global supply chains entail some risk. We have seen in the last five years that they can fail and get overloaded. That means there is a cost of risk. Did companies like Apple buy insurance or count the cost of a potential shutdown in their forecasts to investors? Do economists include such costs in their econometric models? Sadly, the answers are no and no.

Or take climate change. We are already paying a high cost for it yet that cost is not included in any corporate, government, or econometric calculations. Chinese made steel as an example. It is generally agreed by economists and business leaders that China is the world’s low- cost maker of steel. But consider that China imports coal in order to burn it to generate the energy necessary to produce steel. Shipping accounts for about 15 percent of global green- house gas emissions. The actual firing of coal creates enormous additional emissions and the shipping of the steel from China to foreign markets adds a lot more emissions. Is the cost of any of those emissions counted in the price paid by foreign users for Chinese steel? NO. So we really do not know which are the low- cost producers for numerous export markets. It may well be that making steel in the U.S. for the U.S. market is actually the net low cost way to supply the U.S. market.

This whole discussion raises two critical and final points. Yellan is already being criticized by economic establishment voices for abandoning the free trade doctrine of the past forty some years. The problem with this criticism is that few countries actually practiced free trade during that time. Mainly it was the U.S. and UK. Certainly, Japan, South Korea, Taiwan, Singapore, Sweden, Germany, and France all pursued their own industrial and mercantilist policies.

As for China, the free world, and especially the U.S., have been propagating the fairy tale that positive engagement with China and including it in the World Trade Organization would gradually lead it to embrace free trade and globalization a the U.S. or at least a la Japan. This is simply no longer a viable line of argument in the wake of the publication of The Long Game by China expert Rush Doshi. He explains in excruciating detail that from Mao to Xi the policy and course of China has been and will remain to take all measures economically and militarily surpass the United States in manufacturing, technology, and military power.

He notes, for example, that China’s building of the Great Fire Wall to separate its internet from the worldwide web was contrary to free trade and globalization doctrine. It’s huge subsidization of Chinese and state- owned corporations was part of its enormous industrial policy as was its protection of key domestic markets as was its theft of technology and its policy of compelling companies to produce in China if they wished to sell in China. Doshi notes that China’s Made in China 2025 and 2031 policies are completely contrary to any concept of free trade and globalization and that one look at the Xi Jinping regime should convince us that talk of globalization, free trade and positive engagement with China has always been and certainly is today a complete waste of our time and energy.