What both US and China get wrong on economic policy and trade negotiations
- Both sides share the misleading perception that promoting manufacturing is key to job creation, innovation and security
- Their leaders have not recognised that the path to more constructive reengagement on trade issues lies in knowledge-intensive services
Even as the US and China differ on many economic policies, both sides share the misleading perception that promoting manufacturing is key to job creation, innovation and security. Their respective leaders have not recognised that the path to more constructive reengagement on trade lies in knowledge-intensive services.
These actions call into question China’s support for innovation. The premise is that an innovative economy depends more on “hard-tech” manufacturing, such as AI-enabled robotics and electric vehicles, than on “soft-tech” services such as e-commerce and video platforms.
Policymakers in both the US and China have neglected the lessons of economic history. In the aftermath of World War II, economic power was largely defined by the manufacturing prowess of the US and a recovering Europe led by Germany. As the West prospered, however, its economies gradually transitioned to knowledge-intensive services. China and many other emerging market economies are following a similar path.
With few exceptions, all economies have experienced a decline in their share of manufacturing and an increase in services relative to total production as per capita gross domestic product increased over the past three decades.
But most Americans do not realise that the job decline began decades before China’s rise, or that manufacturing output has nevertheless been increasing steadily even though its share of GDP has been shrinking.
The decrease in manufacturing as a share of GDP stems from deep-rooted structural factors. Technological improvements are driving down the prices of manufactured goods more rapidly than services. Also, as economies develop, companies shift from manufacturing to more profitable services.
The path of deindustrialisation is now the norm for high-income economies. Yet America’s political establishment continues to focus on small wins in hi-tech manufacturing instead of recognising the critical role of knowledge-intensive services in driving economic growth.
Decades ago, China was much more restrictive than other major economies, according to the Organisation for Economic Cooperation and Development’s foreign investment restrictiveness index. Today, China has opened up foreign investment in manufacturing to levels comparable to other advanced economies. But for KTI services, China is still much more restrictive.
China fears that its service providers would not be competitive in global, open markets and that national security could be jeopardised. But Chinese companies have matured and would benefit from robust foreign competition while security can be managed.
Both the US and China need to be involved in forging global guidelines if a broadly acceptable framework is to be developed. For China, greater competition with the US would accelerate knowledge transfer and help Chinese firms upgrade skills.
For American hi-tech companies, the Chinese market generates the large profits needed to invest in R&D to maintain an innovative edge. Economic competition puts pressure on both sides to become more productive.
The phase one agreement with China may be good politics, but the logic is questionable. If the US and China want to address the issues that will affect future prosperity, strengthening collaboration in high-value services offers an alternative path.
Yukon Huang is a senior fellow at the Carnegie Endowment for International Peace
Jacob Feldgoise is a junior fellow at the Carnegie Endowment for International Peace