CSIS’ Scott Kennedy on US-China Tech Competition

Scott Kennedy: The basic idea that we want to convey is that the US and China’s economies are highly interdependent. The dominant view in the United States has been to focus on the ‘American dependence’ side of that equation. It suggests that America’s dependence on China’s large market has given Beijing a lot of leverage which it has used to extract concessions from the United States. This has not only hurt the US commercially, but also on the national security front. There may be something to that. On the other hand, China is also dependent on the United States and the rest of the world, and we ought to remember that this gives an advantage to the United States for commercial reasons and even in some ways for its national security. Broadly speaking, we should try to remember and accentuate the type of benefits that the US and others gain from China’s dependence on us. While we need to put some boundaries on the relationship and make some adjustments to the types of technologies we share, we should remember the advantages of the connectivity in the first place. That’s the basic message, that we compete more effectively when we’re connected than when we’re apart. However, we need to make sure we structure that connectivity in a way that is consistent with our values and our goals. As far as advantages, first of all, simply in terms of our technology, the US is still at the top of most technology hierarchies. China has raised its position in those hierarchies, but it’s still behind in most technologies. An American-led or European-led ecosystem is still to our advantage.

The US has a fantastically efficient and vibrant financial system, it has the rule of law, and it has built an international system that reflects a lot of those values. While the international architecture needs some reforms and refinements, it has generally served the US national interest. The US also has a variety of weaknesses that we need to address. Our infrastructure, our educational system, our healthcare system, weakening social trust and the fragmentation between the media and what is viewed as “reality” in the United States, are all troubling. The wide gap between rich and poor is also fundamental to a lot of these challenges.

I think these various weaknesses make us less confident in ourselves and less able to participate confidently in global affairs, including how we interact with China. The Biden administration’s China policy has three pillars: invest, align, and compete. That first one – invest – is extremely important. The administration has already made a lot of progress on that pillar, we’ve seen a variety of legislation passed that aims to make the US competitive with China and slow down tech transfer. However, the US has a lot more work to do at the federal level and the local level, not just by government, but also by civil society to address weaknesses in our own system. In the spring, I visited Taiwan, South Korea, and Japan. While each lacks some aspects of inherent American strength, they are also not beset by the same weaknesses as the US—such as inequality levels. For instance, all of these places have more comprehensive social welfare systems, stronger infrastructure, more effective programs to combat COVID, and higher social trust. I think that these strengths give them more self-confidence when they interact with China. And while there is a lot of overlap between the US and these places on their views of China and policy objectives, there are some differences as well. I think some of those differences reflect more self-confidence about how they’re governing at home. That’s why I think it’s really important for the US to address its own deficiencies, because it will feed into a more effective foreign policy, including how the US interacts with China.

Scott Kennedy: I don’t know whether it was intentional or not for Taiwan to have industries and technologies which are indispensable to China and the rest of the world, but that’s how things ended up. It was not always that way, but in the last 10 years Taiwan’s role in semiconductor manufacturing has become absolutely central. It’s interesting, we did a survey, and we found that there’s mixed opinions in Taiwan about whether their semiconductor industry is some sort of ‘silicon shield.’ That is, because China is so dependent on Taiwanese semiconductors, does that make it less likely to engage in armed conflict with Taiwan? There are mixed opinions about that. Everything else being equal, having a strong semiconductor industry that China and the rest of the world depends on is probably a net benefit to Taiwan’s national security. On the other hand, there are a lot of other variables that affect the likelihood of conflict, and everything isn’t equal. If there’s going to be a conflict, it will be over higher stake issues than just the semiconductor industry. Of course, having a strong semiconductor industry may raise the costs to China and make them think about those costs and evaluate the benefits, but at the end of the day, wars are fought over much greater stakes than any particular industry.

There’s also the other question about whether having a semiconductor manufacturing sector that is so critical to the world makes the US and other countries more likely to aid Taiwan. There again, the reasons why the US and others have for decades upheld a commitment to try to provide some sort of conditional support to Taiwan to help it maintain its defenses, is not about any particular industry. It goes back to the Taiwan Relations Act – it’s about the fact that there is a vibrant democracy there, and that the people of Taiwan should have a say in their own fate. And in the end, if you look at the commitments that the US and China have made, they’ve reached an agreement that whatever outcome eventually emerges it should be achieved peacefully with agreement from all parties concerned. So, that has nothing to do with the strength of TSMC. That’s a very utilitarian look at what is not a straightforward issue, but the consequences for everybody if Taiwan’s semiconductor industry were to go offline would make the recent challenges in supply shortages of semiconductors for the automotive industry pale by comparison. There are material reasons why everyone should have an interest in doing everything they can to avoid a war. However, ultimately that’s not the most critical factor in deciding whether there’ll be war or peace.

Scott Kennedy: If we’re talking about its economic strengths and weaknesses, if you took a snapshot of China at any one time, you’re really liable to see a whole variety of weaknesses. Certainly, if you took a picture right now, you would point to weaknesses of governance, of specific policies, weaknesses in the economic foundations of the financial system, and of consumption. You would see that there are some humongous issues. At the same time, if you look at China as a movie, not a photograph, you’ll see that China is very different today than it was four decades ago. The economy is a lot larger, per capita income is much higher, the physical infrastructure and face of the country looks a lot different than it did 40 years ago. And those are not Potemkin changes; those are genuine changes from the lowliest village to the capital in Beijing. It was not a straight-line path; there’s been lots of twists and turns. There are still significant problems in this economy. Those problems probably reduce China’s potential growth trajectory. Looking ahead, if they don’t effectively deal with the debt and the financial system, that cannot help but slow the country down and potentially create the foundations for a crisis.

Additionally, China’s innovation system still has a whole variety of weaknesses. In 2017, I wrote a report called The Fat Tech Dragon, in which I claimed that while China is innovating, it is doing so in a very wasteful way. China spends a lot to get the innovation it achieves. That is absolutely still the case today. They have an extremely inefficient innovation system, lots of successes, but at a very high cost. Whether you’re talking about electric cars, energy, pharmaceuticals, machine tools, etc. – there has been significant progress, but also an amazing amount of inefficiency. The result is that the economic growth over the last decade has primarily relied on greater inputs into the system. So, total factor productivity’s contribution to economic growth has essentially been reduced to zero. The real measure of the economic strength of an economy is how efficiently it can run, and whether it can become more efficient. How efficiently does it use capital? How much can each worker contribute to the economy? China has a long way to go to make its system more efficient and productive. That’s one challenge in a political economy where you have an ambivalent relationship between the leaders in the government and the party and the private sector – the true engine of economic growth. That is a fundamental challenge that China will have to deal with. China also has an ambivalent attitude about its relationship with the rest of the world. In some places they advocate for globalization and multilateralism, and in other places they show how worried they are about their dependency on the rest of the world. That leads to a whole mix of policies and changes that are not working to China’s economic advantage. China has an interesting mix of strengths and weaknesses, so naturally there’s a range of predictions about its economic trajectory. In fact, that’s why the China prediction business will always be plentiful – because it’s very difficult to figure out which way the country is going.