Five Ways To Counter China’s Economic Might

The expansion of the Soviet Union posed a geopolitical challenge for more than four decades after the end of the Second World War. The West, led by the United States, won the Cold War through a strategy of containment. The Soviet Union collapsed because its economy could no longer support the burden of the massive arms race.

The geopolitical challenge of our generation is how to deal with the rise of China. While the Soviet Union could boast military might while lamenting its economic weakness, China enjoys both military and economic prowess. The West knows how to address the challenge in military terms. But unfortunately, we have little experience dealing with a potential economic superpower. The following five points are the necessary elements to deal with the rise of China.

1) Playing Offense, Not Just Defense

The typical strategy by the West has been to deny access to technologies. The Biden administration hoped to slow China’s advances by cutting the flow of technology. While this strategy still has relevance in sectors where the West has a clear advantage, unfortunately, these sectors are becoming much smaller as China is advancing in technology. In fact, in a growing number of sectors, China is now ahead of the West.

Playing defense will not lead us to victory. We need to play offense as well. We need to strengthen our innovation to stay ahead and catch up. The United States rose to the Soviet Union’s space challenge after the latter first launched the Sputnik satellite, raising fears that America was falling behind. The “Sputnik Shock” encouraged massive investment in innovation. We are already witnessing similar developments in China, such as Huawei and 5G technologies. But unfortunately, our responses so far have not been sufficient. Yes, the West is subsidizing the construction of chip factories. But having manufacturing capacity is not enough. We need to be ahead in technology as well. This will require massive investment in innovation. We have to rise to the Sputnik Shock of our time.

The necessary innovation is not limited to the corporate sector. We will also have to strengthen our scientific base, including our universities. We will have to invest more in our education system to ensure the talents of the next generation are competitive.

The temptation is to erect walls around us to protect our domestic markets. In fact, the United States and EU appear to be moving down this path. This strategy might have worked when the United States and EU were the largest markets. Unfortunately, this strategy is doomed to fail. The markets outside of the United States and EU are much larger today. To compete with China, we need to have a global scale. Trying to survive within the respective markets will buy some time. But it is clear that we will lose our competitiveness over time without the global scale.

Once again, defense alone will not be the answer. We will have to play offense. We will have to cultivate global markets to realize the global scale and ensure global competitiveness.

2) A Collective Approach

Collective self-defense, embodied in NATO and the U.S.-Japan security alliance, helped protect peace after WWII. Unfortunately, we did not apply this wisdom to economic policies. “America First” is fine. Every sovereign country should consider its own interests. But the danger lies in turning this motto into “America alone.”

During the Cold War, the United States found it difficult to deal with the Soviet military threat alone. The collective self-defense network, with the United States at its core, was the key to confronting the Soviet Union. The same is true with the challenge of China’s rise. It is becoming increasingly difficult for any one country, including the United States, to deal with China’s rise in economic power. There have to be collective approaches.

Occasionally, China engages in economic coercion to advance its political agendas. Countries like Australia, which asked legitimate questions about the origin of COVID-19, were targeted with economic coercion. While we cannot launch missiles over such issues, we will have to take whatever measures possible to support the country targeted by economic coercion. Among other appropriate countermeasures, friends can buy more products targeted by economic coercion. If the responses are collective and massive, these countermeasures could deter economic coercion in the future.

In areas in which denial of access to technologies is justified, the measures must be taken collectively by the Western countries with the necessary technologies. Without collective action, the technologies will leak out anyway.

Today, China boasts a large number of global corporate players. In fact, many of them are global leaders in their respective fields. Chinese companies lead the world in telecommunication technologies, solar panels, batteries, and steel. They are coming close to leading the world in wind turbines, EVs, electrolyzers, and shipbuilding. It is becoming more challenging for non-Chinese companies to compete with the Chinese giants effectively. The United States and its allies will have to ensure that they have globally competitive companies as alternatives. The desire to have “National Champions” of our own is becoming a nostalgic sentiment. The harsh reality of competition with China allows little room for nostalgia.

Japan abandoned such nostalgia when it welcomed and even subsidized TSMC, a Taiwanese chip maker, to construct chip factories in Japan. Japan has also decided to depend on non-Chinese foreign alternatives for 5G.

The next test will be in the steel sector. To compete with the Chinese giant steel makers, the proposed merger between Nippon Steel and U.S. Steel makes convincing strategic sense. Without putting the resources of the two companies together, it is hard to draw a path to be able to compete with the Chinese steel giants. It will be a test of whether the U.S. government can fully understand the need for a collective approach to deal with the Chinese giants.

3) A Comprehensive Approach

When China initiated an embargo of rare earth exports to Japan in 2010 in response to the arrest of the captain of a Chinese fishing boat colliding with a Japanese Coast Guard vessel offshore of the Senkaku Islands, Japan was shocked to find out that it was highly dependent on Chinese rare earths for its auto industry. This painful experience shows the difficulty of recognizing the vulnerabilities of the whole supply chain. Comprehensive analyses of various supply chains are extremely important. The response required comprehensiveness as well. Trade measures, capacity investment support, innovation support, and the development of new sources were all necessary. Thus, comprehensiveness is essential for identifying the risks and developing the responses to economic security concerns.

The United States was the first to highlight the risk associated with the domination of the 5G sector by Chinese tech giants. However, the United States was initially slow to recognize similar concerns in critical minerals, clean energy technologies, and data. The United States is still behind in grasping the vulnerabilities in various supply chains as a whole.

The United States lacks a strong government-wide organization responsible for economic security. The National Security Council at the White House theoretically has the authority. However, it lacks the necessary staff and resources to gather and analyze economic security-related intelligence or to coordinate economic security policies effectively.

Japan has a notorious history of compartmentalization within its government. However, in 2020, Prime Minister Shinzo Abe established an economic security team established in the National Security Secretariat of the Prime Minister’s Office. In 2021, Prime Minister Fumio Kishida appointed the first minister in charge of economic security. This year, the  Ministry of Economy, Trade, and Industry (METI) established a bureau responsible for economic security. With the broad scope of economic security issues and the wide range of policy tools necessary, it is time for governments facing economic security concerns to enhance coordination within their ministries to strengthen comprehensiveness in risk assessment and in developing policy responses.

4) Do Not Rule Out Trade

Nowadays, the public image of trade is becoming negative, especially in the United States. But it would be a fatal mistake to rule out trade as a source of American power. Trade and de facto trade through investment are essential to achieving global scale and enhancing competitiveness. If Western companies shy away from international trade while Chinese companies expand their reach, the consequence is clear: we need to trade to stay competitive.

Many Western companies, including U.S. companies, make more revenue outside of their home country. Without trade, companies cannot grow. Limiting growth will certainly be bad for the stock market and the millions of people who invest directly and indirectly in it. It is not just exports. Imports can also help us stay competitive. Having access to competitive inputs can make the users of such inputs more competitive.

Complete decoupling from China is also a mistake. Trade provides vast opportunities for companies to grow. Withdrawing from the enormous Chinese market will hurt many Western companies and countries. Keeping cheap Chinese consumer goods will hurt our consumers and lower their real purchasing power.

Having Chinese companies depend on Western markets will serve as a meaningful deterrent against aggressive behaviors. Having them depend on Western inputs and equipment will also serve as non-insignificant deterrence.

We cannot be naïve. Such deterrence is not perfect. China will take action when it believes its national interests are at stake. However, cutting ties will wipe out such remaining deterrence and sacrifice opportunities for Western companies to grow.

We need to be careful about which technologies to supply and limit. Some products are so sensitive that they warrant prudence. We must be very strategic and selective in determining which technologies to control. Those technologies must be those in which the West enjoys a clear, substantial advantage, and the gap will be difficult to close anytime soon. Other technologies and products should be free to trade.

The importance of trade goes beyond China. Trade helps emerging economies to grow. Their growth will provide markets for our products. Their exports of supplies can help our firms stay competitive. The economic ties with these countries will help strengthen our relationship with them. If we cut trade with them, they will have no other place to go other than China. Cutting trade with emerging countries will make it more difficult for the West to deal with China’s rise.

5) Sound Economic Policy

A strong economy is the foundation of any country. In particular, keeping our economy strong is necessary to deal with China’s rise, which is driven by its impressive economic growth.

In addition to having effective industrial policy, wise trade policy, strengthened innovation policy, and reinforced education system as described above, we need to have sound economic policies in place.

As China struggles with the burst of its real estate bubble, the accumulation of non-performing loans, and growing local government debt, we must proceed in the opposite direction. We need to continue enhancing our financial oversight while implementing sound fiscal and monetary policy. Sound and strong economies can be our greatest asset in dealing with China’s rise, which is now facing a series of economic difficulties. 

Playing the game of great power competition requires planning over a long time horizon. Therefore, we need to have sound economic policies not only for today but also for the long term. In particular, we need to have a proper and sustainable policy to deal with the aging of our population. This trend will put enormous pressure on our social security system and our government finances. China will also face the burden of its rapidly aging population on its social security system and government finances in the coming years. Success in dealing with changing demographics will have a substantial impact on economic competition. Sound economic policy, both in the short term and the long term, is essential for keeping our economies strong enough to withstand China’s rise.

One of China’s strengths is its long-term strategic thinking. To deal with the People’s Republic and its overbearing economic power, the West will also have to think in a similar far-sighted fashion. The five elements highlighted may not be sufficient, but they are necessary to secure the future of American and Western democratic and free-market economies. 

The rise of China presents a pivotal juncture in world history. We cannot afford the luxury of inaction or misguided policies. It is time to think and act strategically to deal with the economic rise of China.

Tatsuya Terazawa is the Chairman and Chief Executive Officer of The Institute of Energy Economics in Japan.

Image: Lushengyi / Shutterstock.com.