How should America compete with China?

Author: David P. Goldman March 29, 2015

Never in the history of American foreign policy has so much egg adhered to so little face as in the matter of Asia Infrastructure Investment Bank. All of America’s allies, including Britain and Australia, have elected to join the Chinese-led institution. That is a grand validation of China’s One Belt/One Road vision for infrastructure upgrades across the whole Eurasian landmass. China’s President Xi Jinping envisions $2.5 trillion of trade between his country and the “Silk Road” nations over the next decade. Rather than fret about the impact of a slowing (or shrinking) world economy on China’s export-driven prosperity, China is seeking to shape the economic environment around it.

It is not only the Obama administration that has been wrong-footed by the world’s embrace of China’s economic ambitions, but almost the whole of America’s foreign-policy elite. With almost no exceptions, American analysts have misunderstood China. One school argues that China inevitably will collapse of its own weight, because authoritarian governments supposedly are incapable of efficient allocation of resources; another warns of a Chinese plan for world domination.

A March 20 Wall Street Journal editorial proclaimed, “China Trounces U.S. ‘Smart Power,’ but expresses sour grapes over the outcome:

The AIIB is likely to enhance China’s influence far more than it will help its supposed beneficiaries. Poor regimes willing to stay on Beijing’s good side will earn cheap loans on lax terms, but the bank will promote a version of China’s state capitalism, not transparent markets.

Gresham’s Law applies to economic development: Bad money drives out good. Ports, bridges and other public works funded by artificially cheap capital, with poor or corrupt oversight, become boondoggles that burden states with debt, raise default risks and often stifle productive private investment. The trillions of dollars Asia needs for public works will never materialize unless private investors see reliable, non-corrupt opportunities for returns. Easy public loans that perpetuate cronyism don’t help.

One would like to ask the Journal editors where in the world they observe an efficient model of private infrastructure investment. American infrastructure is miserable compared to Asia’s newly built roads, trains and bridges, as any traveler who has the misfortune to land at JFK or O’Hare will attest. There is a reason for this: A journeyman bricklayer working on any federally-supported building project in Essex Country, New Jersey is expected to earn $67.26 an hour under the Davis-Bacon Act. That’s $134,520 a year without overtime. American public works projects cost the moon and take forever because they are run for the benefit of the construction unions. American politicians are as terrified to touch this torpedo as their French and Italian counterparts are terrified to amend protective labor laws in their countries. New York City expects to complete its Second Avenue subway line by 2029 at a cost of $17 billion, or 22 years after ground was broken. China builds whole subway systems for cities the size of New York in a year.

Infrastructure is one of China’s great achievements. As the New York Times observed in a Sept. 13, 2013 report, China’s high-speed rail system already serves more passengers than the 54 million Americans who board domestic flights every day, and has transformed China’s economy. With 600 million Chinese migrating from the low-productivity countryside to higher-productivity employment in urban areas, the high-speed rail network has made business ventures possible that were not conceivable before.

A generation of American China-watchers is growing old waiting for China’s economy to crash. There is a parallel thesis, propounded most recently by Brookings Institution scholar David Shambaugh, that China faces a “coming crack-up” for political reasons. It is true that President Xi’s anti-corruption campaign has upset a large part of China’s political elite, but that is not necessarily a sign of political weakness. On the contrary: it is hard for any constituency to oppose Xi on grounds that he has impinged on its parochial interests. Many of China’s economic reforms, moreover, force transparency upon precisely those sectors of the economy that most lent themselves to corruption. The trillion-yuan swap of provincial debt for the obligations of Local Government Financing Vehicles, for example, begins the slow process of shifting provincial infrastructure financing from locally-arranged land sales to tax-financed bonds on the Western model.

A minority of American analysts hold that China will succeed, and that its objective is world domination. That is the nub of Michael Pillsbury’s new book The Hundred-Year Marathon: China’s Secret Strategy to Replace America as the Global Superpower. This I characterized as the “Fu Manchu” theory of Chinese intentions, The leading Chinese news site sina.com had a great deal of fun with this idea, and translated my notice with copies of the covers of the old Fu Manchu novels. Dr. Pillsbury, in fairness, is a serious scholar, and the sensational title of his book doubtless is due to a mercenary publisher Jonesing for impulse purchases. Nonetheless, as I wrote in Asia Times, “China is not planning to take over the world. It doesn’t want the world. It doesn’t like the world – that is, the world outside of China. Unlike Greeks, Romans, Muslims, and European imperialists, it does not want to plant its flag outside its borders, send its young men to conquer and defend new territories, or subject other peoples to colonial rule. Nonetheless, it may inherit the world, reluctantly and by default.”

What should America do in response to a rising China? It is futile and ultimately humiliating to attempt to contain China, as the Obama administration discovered in the case of the AIIB. America should do what it does best, or rather, what it used to do best: Widen the technology gap between America and the rest of the world. That gap is now closing rapidly as a new generation of Chinese entrepreneurs and scientists comes of age. It is closing in part because America’s commitment to basic R&D has faltered.

As Dr. Henry Kressel, former head of RCA Labs, and I wrote in 2013 in American Interest:

One critical but often underrated factor in productivity growth is the impact of basic R&D stemming from aerospace research and development. Between 1952 and 1964, as the Eisenhower and Kennedy Administrations responded to Russian development of nuclear weapons and space flight, R&D spending rose by more than an order of magnitude. During the Johnson, Nixon, Ford and Carter Administrations, though, Federal R&D spending grew very little. When America shifted budget priorities toward increasing Federal entitlements and funding the Vietnam War, Federal R&D spending declined. It rose, although not as fast as during the 1950s and 1960s, during the Reagan Administration under the impetus of the Strategic Defense Initiative and the rearmament program.

America’s response to Sputnik set in motion the eventual productivity recovery of the 1980s, with the fastest rate of increase of federally funded R&D in the nation’s history. It is difficult to identify the fundamental research component in overall R&D spending, to be sure, but a rough proxy is the percentage of Federal R&D spending. The Defense Department, NASA and the Department of Energy have provided a disproportionate share of funding for research with long-range objectives in basic science as opposed to incremental improvements on existing technologies. Federal R&D spending has fallen from nearly 2 percent of GDP in 1963, at the height of the Cold War and space program, to less than 1 percent during the past two decades. That may not sound like much, but as with falling infrastructure investment, 1 percent compounded over a decade or two is a very significant number.

America should be reliving the Sputnik moment of 1957, when Russia’s first space flight prompted a big shift in resources towards science education and basic R&D. America also should make it easier for foreign students (who comprise a disproportionate share of our scientific and engineering student body) to settle in the U.S. and obtain funding for new ventures. China and the United States never will be allies, and probably won’t be friends, but the world’s two largest economies can compete peacefully for the high ground of technological innovation. That’s what America once did best. If America can’t sustain its commitment to innovation, its complaints about China’s ascendance will be futile.

http://atimes.com/2015/03/how-should-america-compete-with-china/