The Real China Threat

Deng Xiaoping once famously counseled his countrymen to “hide our capacities and bide our time”—a nod to playing the long game for which China is famous. For the last few decades, China has followed Deng’s advice, ramping up its manufacturing capacity with the help of state subsidies, foreign investment, and cheap labor. For years, China was thought of as the world’s factory floor, exporting cheap sneakers, T-shirts, and plastic toys around the globe. Lately, though, China has set its sights on higher-tech industries. Its “Made in China 2025” plan calls for rapid development in 10 high-tech fields including robotics, artificial intelligence, telecommunications, and aerospace engineering.

Economists have long explained the virtues of free trade by pointing to the concept of comparative advantage, in which countries benefit by specializing. If Portugal excels at making wine and Britain excels at making cloth, both countries benefit by trading Portuguese wine for British cloth—more than they would if both produced wine and cloth. As applied to the United States and China, policymakers from both major parties have been until lately content to allow China to specialize in manufacturing—where it has advantages because of lower labor costs—while the United States focuses on developing an economy more rooted in higher-paying, knowledge-based services. George H. W. Bush’s chief economist, Michael Boskin, is said to have quipped that there’s no economic difference between making potato chips and computer chips. Former Obama economic adviser Christina Romer wrote in 2012 that “a government manufacturing policy has to go beyond the feeling that it’s better to produce ‘real things’ than services. American consumers value health care and haircuts as much as washing machines and hair dryers.”

The government’s hands-off attitude reaped huge benefits for the U.S. economy, such as the ascendancy of Silicon Valley and the creation of whole industries that would have been unimaginable in earlier eras. But it’s also becoming evident that this approach came with costs, too—chiefly, the loss of 7 million manufacturing jobs in the last 40 years and the concomitant political backlash in 2016 stemming from the perception that government inaction or mismanagement was to blame. More recently, the Pentagon has been sounding the alarm that in some areas, so much production has migrated overseas that it is tough to find materials for weapons systems made in the United States or by an ally.

“It’s a problem—a big problem. And it has the potential to grow,” says retired Air Force general Hawk Carlisle, who heads the National Defense Industrial Association, a trade association of defense contractors. “The reason it has arisen is because the Chinese are so much more aggressive about it. They continue to improve their capabilities, and we know what their intentions are. We know they would love to undermine our defense capabilities.”

A September report from the Defense Department found a “surprising level of foreign dependence on competitor nations” for defense materials. The challenges of acquiring the needed high-tech goods from countries that are not adversaries “have the potential to result in limited capabilities, insecurity of supply, lack of R&D, program delays, and an inability to surge in times of crisis,” it said.

Carlisle and others say dependence on foreign-made defense components isn’t just a theoretical future danger. It is already happening in sectors including semiconductors, flat-panel aircraft displays, and solar panels. These are all what are known as “dual-use” technologies, with military and consumer applications. Each of these products is largely made in Asia in part because the Chinese market is far larger than the U.S. market. Fifty years ago, U.S. technology companies could rely on defense spending to bankroll research and provide financial support. For example, the Internet and global positioning systems were largely developed with defense funding. But now, the demand for consumer electronics is so large that private companies are the ones that tend to do the innovating, with consumers as the target market, and most of their production happens outside the United States.

“Say you’re making the latest generation of a helicopter, and you want flat-panel displays for the cockpit. Where do they come from? From Asia. They all come from two time zones in Asia,” says Willy Shih, a Harvard economist who studies technology and manufacturing. “I’d say 70 percent of the world’s semiconductor foundry capacity is in three science parks in Taiwan. All of the small optical sensors come from Asia. Touchscreens—from Asia. Camera components, optical components—Asia.”

Additionally, the Defense report found that there are other areas that are threatened, including machine tools, composite materials, and printed circuit boards. About 90 percent of the world’s printed circuit boards are made in Asia, with more than half made in China—while the “U.S. printed circuit board sub-sector is aging, constricting, and failing to maintain the state of the art.”

Chinese dominance in making high-tech equipment doesn’t necessarily constitute a national security crisis. But the fear is that if tensions with China were to escalate, China could cut off the supply of critical U.S. military components. Recent sparring between the United States and China over technology equipment companies such as Huawei and ZTE reflects U.S. worries that China could try to gain a military advantage by designing electrical components that it secretly controls. In 2010, the U.S. Navy bought 59,000 computer chips destined for helicopters that were discovered to be counterfeits containing a “Trojan horse” or “kill switch” flaw that would have allowed an enemy to render the helicopter’s weapons inoperable. In October of this year, Bloomberg Businessweek reported that the Chinese military had secretly inserted microchips the size of a grain of rice on server motherboards made in China that wound up in the mainframes of nearly 30 companies, including Apple, for the purpose of conducting industrial espionage.

China understands that dominating the international supply chains for high-tech products gives it power, Shih says: “They see the political leverage that comes from controlling sources of critical components.” U.S. companies routinely complain that China has a number of unfair advantages in seeking to control high-tech industries. They say China steals proprietary information, fails to honor intellectual property rights, and requires American companies to share technology upon investing in the country.

Another area of concern is China’s mining of what are known as rare-earth minerals, used in the production of batteries, lasers, radars, night-vision systems, and other electronics. In 2017, Chinese mines accounted for 81 percent of the world’s rare-earth minerals, according to the U.S. Geological Survey. The United States hasn’t mined any such minerals since 2015. The Pentagon report notes, “China has strategically flooded the global market with rare earths at subsidized prices, driven out competitors, and deterred new market entrants.” In what U.S. planners see as a cautionary tale about Chinese dominance, in 2010, China halted shipments of rare-earth minerals to Japan following a maritime dispute.

Once these advanced industries migrate to another country, it becomes difficult for them to return. Most technological advances take place where the manufacturing takes place, says Rob Atkinson, president of the Information Technology and Innovation Foundation, a Washington think tank that focuses on science and technology.

“These industries are not like soybeans, where, if China puts big tariffs on our soybean farmers, then we have less soybeans for 10 years,” he says. “You can turn that around in a couple growing seasons. . . . When you lose advanced technological industrial capability, it’s very, very difficult to get it back. It’s a complex recipe. You can’t just buy a book or license a patent. It’s pretty deep technical know-how.”

He says the blame for the loss of high-tech manufacturing falls on presidential administrations dating back to Richard Nixon. Leaders, he says, failed to develop a comprehensive strategy to nurture critical technologies in this country. They believed that making overtures to China would prompt China to open its economy to the world, relax state control over industry, and favor the rule of law. “This was just a naïve view,” Atkinson says. “It was fundamentally wrong.”

He says the solution is for the government, finally, to develop a plan. In April, a bipartisan group of senators—Todd Young (R-Ind.), Jeff Merkley (D-Ore.), Marco Rubio (R-Fla.), and Chris Coons (D-Del.)—introduced a bill requiring the executive branch to develop a national economic security strategy to combat “predatory economic practices” of other countries. The bill went nowhere.

There are plenty of other tactics that could help, too, including spending more to boost potential military suppliers, training more workers for science and technology jobs, seeking new suppliers in friendly countries, re-engineering equipment to depend less on hostile foreign suppliers, and increasing stockpiles of critical elements. Yet those seem like band-aid solutions on a much larger wound.

Donald Trump and Xi Jinping might well resolve the tariff dispute. But the larger issue of high-tech dominance is far thornier. It doesn’t lend itself to a handshake deal and a victorious tweet.