Last week, the Peterson Institute for International Economics presented former U.S. Trade Representative, Deputy Secretary of State, and World Bank President Robert Zoellick along with former Treasury Secretary and Harvard University President Lawrence Summers to discuss the pros and cons of the Biden administration’s trade and China policies.
To begin, I should note that I know, have often engaged in debate with, and respect both men for their dedicated public service.
I have also strongly disagreed with both of them in the past on major issues of trade, globalization, competitiveness, industrial policy, and China policy. Summers, as perhaps America’s most prominent economist, has long been a dedicated disciple of free trade and globalization while opposing U.S. industrial policies as well as U.S. efforts to offset the impact on the U.S. economy of the industrial policies of many of our trading partners. Zoellick has long shared Summers’ views, but has added the thought that “we” (Americans, the free world, those dedicated to open trade and globalization) “want China to become a responsible stakeholder in the (our?) liberal, rules based, global system.”
In view of the fact that President Biden and the U.S. Congress have recently passed and signed into law the Chips Act as an industrial policy that will subsidize development and production of advanced semiconductors by U.S. makers, and that just a few days earlier National Security Adviser Jake Sullivan had called for halting U.S. sales of advanced semi-conductor chips and chip making equipment to China, and that Treasury Secretary Janet Yellen, while denying any desire for de-coupling form China followed up on Sullivan’s remarks by saying that while the Biden administration is not calling for de-coupling, it is taking steps to “de-risk” America’s economic ties with China, I watched with great expectations to hear the reactions to all this of Summers and Zoellick.
Summers surprised me. Of course, he did not abandon the free trade gospel of conventional, neo-classical economics, but he did say that he understood the U.S. national security need to hold back on supplying a potential adversary like China with the latest, most powerful, most up to date equipment such as advanced semiconductor processors. It wasn’t heresy, but it was close enough that I had to give Larry credit for courage and honesty. He went on to repeat the conventional mantra that free trade should be the rule, and that protectionism is costly to consumers, but he had made a very logical exception.
Though not a professional economist, Zoellick remained more conventional, asserting that China cannot be contained and that depriving it of advanced technologies is self-defeating because that will only drive China to develop its own cutting edge technology faster. In saying this, he overlooked the fact that with its 2015 Made in China 2025 policy, China long ago clearly and loudly announced that it is already fully dedicated to developing and making its own. Indeed, this is why there is so much concern about forced tech transfer today among foreign companies operating in China. Obviously, any technology one transfers is simply going to be squeezed into the Made in China mold asap.
THE FUNDAMENTAL DIVIDE - MERCANTILISM
Despite these differences in their responses, Summers and Zoellick remained united in their fealty to the fundamental doctrines of neo-classical free trade. They agreed, for example, that the tariffs on steel imports from China first imposed by then Republican President Trump and now maintained by Democratic President Biden are only benefiting a few American steel workers, executives, and shareholders while increasing prices for the vast majority of American consumers. They agreed that the American market should remain open to imports from other countries even if those countries subsidized their exports and imposed restraints to keep U.S. exports out of their markets. They also were surprisingly unworried by the chronic U.S. trade deficit of about three percent of GDP and the U.S. international debt of $35 plus trillion dollars that has accumulated since 1980 (the U.S. was then a creditor nation). Nor did they discuss the chronic over-valuation of the U.S. dollar and the currency manipulation by other countries (especially China) that causes this.
In short, these two very prominent, highly educated at the best schools (they did not need “legacy” consideration or a tweak of their SAT scores), and highly experienced economic/financial leaders did not mention or give any indication of knowing about how all the rich countries (except oil producers) have become rich over roughly the past two hundred and fifty years.
The unmentionable word is “mercantilism” but one should really think of “increasing returns to scale”, meaning that costs decline as production increases.- Let me explain it in a somewhat backwards historical way by looking at a relatively recent maneuver by China that demonstrates Beijing’s keen understanding of what Zoellick and Summers fear to mention.
In 1954, Bell Labs developed the first commercially viable voltaic cell that was eventually used in space satellites as a kind of early solar panel. By the early 1990s, the U.S. produced about a third of the world’s solar panels. However, by the turn of the century a strong dollar, disinterest on the part of the U.S. government, and active industrial policies (including subsidies for production and buy national orders) in Japan and Germany had shifted the vast bulk of panel production to those countries. Then, in the early 2000s, China also entered the game with subsidies for panel production and limitations on panel imports.
Between 2000-2010, Germany was the world’s leading producer. After 2010, China put the pedal to the metal by pouring subsidies into production facilities and installations while maintaining a “buy Chinese” policy. This created a huge, protected domestic market for an industry very much subject to the phenomenon of economies of scale. In such industries, which include most manufacturing industries such as steel, semiconductors, autos, and many others, the cost of production declines as the amount of production rises. So, while in the year 2005, China’s production costs for solar panels may have been higher than Germany’s, and the champions of free trade such as Zoellick and Summers were arguing that China should import its panels from Germany, by the period 2010-2015, China, based on its massive and guaranteed domestic market had become the global low cost producer and increased its economies of scale by now supplying the large and growing export markets in the U.S., and the EU which, true to their commitments under the rules of the World Trade Organization, kept their markets open to imports from China despite its own “buy China” policy.
Free trade devotees today may complain that China is behaving unfairly, but, in fact, it is merely imitating the policies used first by England, then by the United States, Germany, and France, and finally by Japan, South Korea, Taiwan, and Singapore to get rich. In the fourteenth century King Edward III of England limited exports of wool to Europe and imposed a tariff on imports of cloth. He perceived that while wool was a commodity characterized by fluctuating prices dependent on weather and the fecundity of animals, the production of fine cloth entailed developing skills that added substantial value which actually increased as production rose and the cost of production per item fell. This phenomenon is known as “increasing returns to scale” and sharply differentiates weaving and other manufacturing from farming, mining, fishing, and other commodity businesses in which increased production entails ever higher costs.
Edward’s policy is called mercantilism and is harshly condemned today by the likes of Zoellick and Summers and the economics and trade elite of the Anglo countries. But it is what made England and then Great Britain the leader of the industrial revolution and the dominant world economy of the 18th, 19th, and early 20th centuries. It was also through mercantilism that America became industrialized, rich, and the dominant power of the later 20th century. Germany, France, Sweden, Switzerland, Italy and later also Japan, South Korea, Taiwan, and Singapore followed suit as China is also now doing.
In the case of the United States, a great debate raged from about 1790 until 1814 between Alexander Hamilton who embraced mercantilism and the industrial revolution and Thomas Jefferson who insisted on trying to build an America of yeoman farmers. That the young United States nearly lost the War of 1812 to Britain for lack of capacity to produce the products necessary for war, changed Jefferson’s mind and from 1816 until about 1950, imposed high tariffs on imports of manufactured goods while subsidizing the development of its own industrial base.
In the middle of the Civil War, President Lincoln raised tariffs on steel imports higher new levels. In responding to critics, Lincoln noted that: “ I don’t know much about steel or tariffs, but I do know that if we buy steel from Britain, it gets the money and we get the steel. But, if we make the steel ourselves we get the steel and keep the money.”
My own career has involved spending a lot of time living in Japan and studying its history of economic development. Perhaps the most enlightening comment ever made to me about how Japan succeeded in recovering from the devastation of WWII and becoming a leader in a wide range of advanced industries was that made by Vice Minister of the Ministry of International Trade and Industry, Amaya Naohiro. He said: “Clyde, we did the opposite of what the open market, free trade oriented American economists recommended that we do. They urged us to concentrate on agriculture production of toys and simple manufactures. But we knew that America itself had not become rich and beaten the hell out of us by growing corn and making kids’ toys. We listened politely, but then went our own way to again become major producers of steel, ships, autos, semiconductors, and the rest of the full array of advanced manufactures which are characterized by increasing returns to the scale of production. Unless a country is very lucky and strikes big oil, developing industries with increasing returns to scale is the only path to sustained high income and a safe and comfortable life.”
THE NATURE OF CHINA
I was fascinated by the fact that neither Zoellick nor Summers mentioned the unusual nature of China’s system and how that stands in the way of the Flat World assumptions of most journalists and neo-classical economists. Let me return to Deng Xiaoping and his instructions to his Communist Party followers to: “ bide your time and hide your light.” Obviously, Deng was plotting some change that he was not yet ready to make public to the world. Let us also not forget that the Chinese Communist Party is a Leninist Party which means it assumes that anything not under its control is potentially dangerous and in need of close, even intimate, watching.
Add to this Xi Jinping’s clear intent to achieve a return of China to its fabled pre 19th century status ( at least in its own mind) of first among nations, first among civilizations. Zoellick still speaks of China as a responsible stakeholder in the so called rules based system, but it is more than clear Xi does not want China to be a mere stakeholder in some heavily free world influenced system. He wants China to be the dominant player in a whole new system that is unlikely to be either rules based or liberal. Such a system would be the antithesis of the CCP led China that Xi envisions. As a good Leninist, Xi cannot want a liberal system. It would be the antithesis of his long, dedicated career and gigantic effort to yank China into a latter day Qing Empire.
It is in that context that we must consider recent statements not only by Zoellick and Summers but also by the likes of French President Emmanuel Macron and his Minister of Economics and Finance Bruno Le Maire to the effect that the free world does not want to de-couple from China or even to “de-risk” because, of course, there is no “risk” in the normal sense of that word.
I must admit to being baffled by this line of talk. It has to be clear by now that Xi and the Chinese Communist Party he dominates and that dominates China does not want to and will not play the liberal, democratic, “free trade” game of free and equal globalization. They will strive to dominate the key technologies, gateways, production techniques, and markets of the future by dint of mercantilism, industrial policy, military-commercial fusion, hostage taking (easy to do because of no rule of law) of major corporations like Apple and Volkswagen, and penetration of free world data bases. U.S. National Security Adviser Jake Sullivan understands this even if Janet Yellen and Bruno Le Maire do not.
WHAT IS TO BE DONE
COPY THEM. DO MERCANTILISM BETTER THAN THEY CAN. This is something we not only know how to do but at which we have been outstanding in the past. We have already started with semiconductor chips. Let’s extend that to solar panels, EV autos, AI, and all the other key technological industries now rapidly rising. The U.S. and the free world have vast markets in which to obtain economies of scale. We should stop importing Chinese panels and focus on making our own. It might cost a bit more at first, but with economies of scale the costs and prices will inevitably fall. In addition, doing this kind of work will inevitably lead to new inventions and better systems that will be dominated by free world makers rather than by Communist China makers.
A major part of any American and free world response effort must be to stop the over-valuation of the U.S. dollar which Forbes says is 15 percent over-valued. If Washington were to impose even a five percent surcharge or Market Access Charge (MAC) on all in-coming foreign investment that is not aimed at creating new production facilities, the global economy would begin to swing in a very different way. President Biden should really give this careful consideration because for sure Donald Trump has thought about it.
I could go on with a lot of details and I will do some more of that later. But for now, the key is to stop acting like a cry baby and to stop blaming China when the problem is really us and our lack of serious consideration of how to build and operate a truly first class competitive economy in a world in which we are no longer the overwhelmingly dominant player. We need to stop thinking about “responsible stakeholders” and start focusing again on being really and truly competitive. We can learn a lot from studying what China has done and is doing and also by rereading our own history, particularly in view of the fact that the thinking of the standard Washington think tanks and elite universities is soooo empty and old.
Clyde Prestowitz is President of the Economic Strategy Institute and Director of Global Strategy for Cardinal Global Wealth Management. He is the author of ten books on globalization and competitiveness, served in the Reagan and Clinton administrations, and has been an advisor to Presidents Reagan, Clinton, and Obama.
Great point on solar. I have been arguing for decades that the federal government needs to jump start making every home and building in America solar where the sunshine warrants it, for national security reasons tied to weaning us from non-US oil. Now we can't without making China rich as the main solar panel exporter. Your mercantilism points are long overdue to return as mainstream modern global conomy thinking.
Fair minded critique of Summers and Zoellick. Also, unlike say Bob Lighthizer, Clyde doesn’t shy away from the mercantilist label. But this shouldn’t be an exercise in name calling. China has skillfully used industrial policy to advance, as did Japan. So has the US, often via the Pentagon and its predecessors. This isn’t just simply a question of who offers the biggest subsidies. Completion needs to be a big part of the equation. Otherwise industrial policy becomes just another lobbying trough.