The Wages of Washington’s Economic War on China Are Not Cheap

Decades ago, Washington first sought to isolate the People’s Republic of China (PRC). Then President Richard Nixon turned China into a friendly geopolitical counterweight to the Soviet Union. After the 1976 death of Mao Zedong, the PRC joined the global marketplace. China’s rapid transformation was a boon to Americans. The process also helped spur greater liberty in the PRC. The 1989 Tiananmen Square crackdown, however, ended official efforts at political reform.

Despite Tiananmen’s tragic outcome, the Chinese were still freer than under Mao, whose reign was filled with madcap, bloody chaos. Unfortunately, Xi Jinping, who took over the Chinese Communist Party a decade ago, has turned the PRC back toward Maoist tyranny. Today, Beijing boasts a Leninist state ever-ready to conscript China’s substantial private sector, posing an unusual challenge to the US.

Although Xi has tightened political controls, the future is not set and the process could again reverse, with liberal reform retaking the lead. Thus, while past Western “engagement” was not enough to turn China democratic, maintaining substantial economic, cultural, and political ties with the PRC should remain an important objective of US policy toward Beijing.

Confrontation, however, has taken over US-China relations. Indeed, the new battle cry in the US is decoupling. Observed Asia Society President Kevin Rudd: 

Pundits, think tanks, and governments alike are producing plans to loosen links between the US and Chinese economies.

Decoupling is being driven by the PRC as well as the US. Beijing is choosing to step back from the market. According to J. Stewart Black and Allen J. Morrison, “From the Chinese perspective, however, decoupling is a strategic shift whereby China switches its focus from economic growth to economic control.” Even more important, the PRC fears the consequences of being denied access to the dominant American market. Noted Rudd, Beijing’s goal now is to create “fortress China” through technological self-sufficiency.

There are differences of degree in decoupling. Jon Batemen of the Carnegie Endowment for International Peace, for example, offered his “centrist” approach, emphasizing “finely tuned defensive measures plus large offensive investments.”

The simplest measures reflect concern over supply chains viewed as overly dependent on the PRC, such as for personal protective equipment and pharmaceuticals, leaving other nations vulnerable to disruptions. Other iterations are rooted in national security, the belief that certain important technologies should be produced at home instead of in China, or should be denied to China. This requires banning sales to the PRC or investment in it.

Adding some diversity to supply chains might be good practice for US concerns, if not adopted for protectionist purposes. The private sector, however, remains best positioned to address supply problems. And it has adapted to the COVID-19 pandemic. Explained the Cato Institute’s Scott Lincicome: “Far less reported…is how the US and global manufacturing sectors immediately began adjusting to whatever supply chain challenges arose. There is perhaps no better example than the medical goods in such short supply early [2020]. … By January 2021, in fact, members of Congress were writing President Biden to complain of a potential glut of American-made PPE!”

Ensuring access to strategic goods with limited economic markets can warrant targeted government support. Indeed, the US already has passed a gaggle of bills intended to support the military industrial base and is cooperating with democratic and allied governments. The increasingly fractious nature of China’s relations with democratic states justifies a collective review of reliance on the PRC in key areas and improved cooperation to ease conditions hindering private investment elsewhere. Domestic interests, however, are ever ready to abuse such arguments, using them as excuses rather than justifications.

Similar is the issue of trade with, investment in, and purchases by Chinese enterprises. The US government has long imposed various restrictions on such transactions based on security considerations and Congress tightened those controls four years ago. The Biden administration recently issued an executive order further restricting foreign investment in the US. Advocates of more radical decoupling would expand the ambit of such restrictions well beyond truly strategic goods.

The focus should be on nominally private enterprises used by the Chinese state for malign purposes, and restricting contact with these entities. Such restrictions are most effective when targeted narrowly and applied multilaterally. Examples include military-related goods, as well as other sensitive items, such as surveillance equipment, often used to violate human rights. Also targeted today are firms that accumulate private data ‚and use civilian products critical for important technological development (e.g., semiconductor chips).

Some policymakers would eliminate mutual dependence on anything but the most mundane goods. Seeking to exclude the PRC from most national and global markets is, however, futile. That political, rather than economic, exercise would be extraordinarily disruptive, expensive, and unrealistic, given China’s vast commercial engagement around the world. Unilateral US decoupling would be foolish, achieving little benefit for the high cost involved. Indeed, severing the most important links among people and nations would hasten the ongoing deterioration in Sino-American relations and reduce the economic barrier to conflict.

The broader the goods and services affected, the greater the resistance from other nations. Indeed, a Global South unwilling to sanction Russia over its invasion of Ukraine is unlikely to abandon China. Even among allied governments sharply critical of Beijing, few would support such a draconian step. Hence the spectacle of German Chancellor Olaf Scholz heading to China in search of business while the Biden administration escalated its technological offensive against the PRC.

Even centrist Bateman warned: 

The complexity of the issue is reflected by Huawei, the Chinese telecommunications firm which features 5G technology, and is at least a generation ahead of US firms. There is reason to worry about the Chinese state’s using Huawei’s role in providing wireless networks to commit cyber-espionage in commercial as well as national security matters, though there are ways to mitigate the risks. Washington’s attempt to build a coalition to ban Huawei has proved difficult. The firm provides a cheap service not available from any US firm. Many countries, developing states in particular, rely on Huawei despite America’s pressure.

Semiconductors may be the most important, or at least best-publicized, issue to date. There is widespread support in Washington to prevent or at least inhibit the PRC from participating in foreign markets in an attempt to slow advances by and limit resources of Chinese chipmakers.

Increasing US restrictions on Chinese access to semiconductor chips have hindered PRC firms’ efforts to develop more advanced products. In October, the administration went even further, prohibiting “firms from providing certain advanced semiconductors to Chinese companies unless they secure permission from Washington. The administration will also block the acquisition of sophisticated US-manufactured chipmaking tools by leading Chinese firms and slap additional restrictions on dozens of Chinese companies.” This is technological warfare, intended to both slow and limit (or “kneecap,” in one observer’s evocative description) Chinese economic development.

In the short term, the PRC will suffer. Such limits will, however, have counterproductive consequences for America as well. The tougher the standards, the less broad the international coalition will be, limiting the long-term impact of sanctions. The administration’s latest move came without agreement from important countries such as Japan, South Korea, and the Netherlands. Washington apparently assumed that threats of sanctions would force their submission. This tactic is sure to generate resentment and resistance.

In fact, the new restrictions risk breaking the consensus behind earlier measures and spurring creation of a separate market servicing Chinese enterprises. Douglas Fuller at the Copenhagen Business School observed of the Biden administration’s earlier regulatory fusillade: “This kind of broad measure is likely to be effective in the short term but would create precisely the required domestic coalition of tech companies and state interests that China needs to create alternatives to the know-how of techno-democracies in the long term.”

Limiting chip sales also has sharply reduced revenue for US firms. The latest controls will greatly increase the loss, cutting private capital expenditures, R&D spending, and employment by US companies. Warned the Boston Consulting Group: “in a scenario in which escalating tensions lead to further restrictions on US semiconductor sales to Chinese customers, South Korea would likely overtake the US as world semiconductor leader in a few years; China could attain leadership in the long term.”

Trying to fully reshore chip production would be extraordinarily expensive. One US estimate is that “fully self-sufficient local supply chains would require at least $1 trillion in upfront investment, incur $45 to $125 billion in incremental recurrent annual operational costs for the entire industry, and result in a 35 to 65 percent overall increase in chip prices.” And what of the duplication if other allied states seek to do the same?

The broader the US proscription on Chinese use of US-influenced chips, the greater the incentive for the PRC to design its own chips and foreign concerns to aid Beijing. Ironically, US controls already have spurred domestic Chinese production. Reported Time: “China’s chip industry is growing faster than anywhere else in the world, after US sanctions on local champions from Huawei Technologies Co. to Hikvision spurred appetite for home-grown components.”

The longer-term impact of the latest rules could, according to Paul Triolo, be sharply negative for America: “US tech companies, in particular in the semiconductor sector, are concerned that actions like blacklisting so many leading Chinese tech firms, from ZTE to Huawei, to supercomputer firm Sugon, AI leaders Megvii, Sensetime, and IFlytek, are already leading Chinese and firms in other countries to ‘design out’ US technology.”

Rather like Vladimir Putin’s attack on Ukraine, the Biden administration’s latest technological assault on the PRC might have seemed like a good idea at the time. There obviously are legitimate concerns over Beijing’s behavior and its use of commercial advantage for geopolitical ends, which justifies some restrictions on China’s access to advanced Western technology. Such rules are, however, easily abused for commercial and protectionist purposes.

Moreover, the unintended consequences of draconian controls are likely to be enormous. Denying the PRC access to important technology will be difficult. The mere attempt will encourage efforts by China to develop its own system. And to make up lost revenue, the US industry may become more dependent on government largesse and ultimately less vibrant and dominating. Ultimately, making policy more like China risks turning US industry into something more like China’s.