The Myth Behind China's Miracle

George J. Gilboy

From Foreign Affairs, July/August 2004

Summary:  Washington need not worry about China's economic boom, much less respond with protectionism. Although China controls more of the world's exports than ever before, its high-return high-tech industries are dominated by foreign companies. And Chinese firms will not displace them any time soon: Beijing's one-party politics have bred a timid business culture that prevents domestic firms from developing key technologies and keeps them dependent on the West.

George J. Gilboy is a senior manager at a major multinational firm in Beijing, where he has been working since 1995, and a research affiliate at the Center for International Studies at the Massachusetts Institute of Technology.

Rather than thinking of China as yet another Asian technological and economic "giant," it may be more useful to regard it, like Brazil or India, as a "normal" emerging industrial power. Thanks to the interaction of political structure and industrial culture, China's twenty-first-century technological and economic landscape looks like a pattern of "nodes without roads" -- a few poorly connected centers of technological success. Burdened by these peculiarities, China has yet to lay the domestic institutional foundations for becoming a technological and economic superpower. Without structural political reforms, its ability to indigenize, develop, and diffuse technology will remain limited. And most of its industrial firms will struggle to realize exiguous margins at the lower reaches of global industrial production chains.

STRATEGIC ENGAGEMENT

Given these limits on China's potential to threaten the global balance of economic power, the United States should resist the false promise of protectionism, whether in the form adopted by the Bush administration (rhetorical jabs at the Chinese currency peg) or that recommended by the AFL-CIO labor federation (calls for tariff protection in the guise of better rights for Chinese workers).

Rather, recognizing both the challenges and the opportunities presented by China's industrial landscape, Washington should pursue a policy of strategic engagement with Beijing. The purpose of this policy would be to bolster U.S. technological, economic, and political leadership, while helping China become more prosperous, stable, and integrated into global economic networks. Pursuing it will require simultaneously strengthening the basis for U.S. technological and manufacturing mastery in the United States and promoting U.S. exports, investment, and liberal values abroad.

The United States should revitalize manufacturing at home, for example. Tax cuts are no panacea; the United States needs focused policies to strengthen R&D, reduce legal and health care costs, and improve education. Innovation is critical to growth, but R&D spending in the United States has declined in relative terms from 60 percent of world R&D in the 1960s to 30 percent today. Meanwhile, although U.S. manufacturing productivity has risen by 27 percent in the last five years, health care premiums have risen by 34 percent and litigation costs by about 33 percent, according to the National Association of Manufacturers.

To maintain its lead abroad, the United States should push its products into the portal opened by its investment "snakeheads" in developing markets. It currently lags behind competitors in doing so: while Japan and the EU exported $79 billion and $49 billion in goods to China last year, the United States exported only $37 billion. Both the U.S. government and U.S. industry must do more to help small and medium-sized U.S. firms reach out to China's markets.

The United States must accept that China is a work in progress and cannot yet meet all of the standards common in advanced industrialized economies. But focused bilateral sanctions, WTO complaints, and multilateral diplomacy should be vigorously pursued if China undertakes unfair trade practices that challenge core U.S. interests. The United States should prioritize carefully, however, focusing on the issues that pose the greatest threats and present the greatest opportunities. These include China's recent attempts to impose technical standards on foreign firms in China, such as for DVD players, wireless communications, and mobile telephones, or to tax imported goods such as integrated circuits (a policy tantamount to a domestic subsidy and prohibited by WTO rules). Washington should also urge Beijing to curb investments in excess manufacturing capacity, as they could threaten key industries such as automobiles and semiconductors.

Continued engagement of this kind will help the United States consolidate the benefits it already reaps from the current relationship, ensure China's continued prosperity and stability, and encourage China to play by global rules. Working with its allies to further incorporate China's economy in international trade and industrial networks, the United States can reinforce the technological leadership of the advanced industrialized democracies, while diminishing the scope for Chinese technological and economic mercantilism.

The paradox of China's technological and economic power is that China must implement structural political reforms, not simply freer markets or greater investment, before it can unlock its potential as a global competitor. But if it were to undertake such reforms, it would likely discover even greater common interests with the United States and other industrialized democracies. Pursuing strategic engagement is thus a way for the United States to hedge its bets: to preserve its competitive edge while encouraging China to continue developing its economy and liberalizing its politics. Chinese political reform is in the long-term interest of both Beijing and Washington. Unfortunately, the burden of a long history of fragmentation and authoritarian rule weighs heavily against China's successfully completing this final modernization.