The U.S. Must Learn From China's State Capitalism to Beat It

Free markets alone won't be enough if we want to keep pace with China. It's time for some new-fashioned industrial policy.


Over the last decade, free-market policies have lost their punch in creating jobs, new industries, wealth, and a bright future for the United States. Chinese state capitalism, on the other hand, has won round after economic round by violating free-market principles. Have those principles failed us? If so, why?

China has undercut those principles with an economic strategy to disrupt our free-market and open-trade system. U.S leaders have not mounted a potent response. They engage in piecemeal actions: lodging trade complaints with the World Trade Organization; railing about currency undervaluation; passing disjointed laws shaped by lobbyists; applying sporadic diplomatic pressure to reform China.

But tactics are not a strategy. And these tactics have not worked. Our massive trade deficit with China remains.

President Obama and Mitt Romney duel over who would be tougher on China. But getting tough is not a strategy. A strategy will emerge from understanding why our system is underperforming. And it will emerge from pinpointing how the Chinese system has disrupted our advantages.

For starters, China has disrupted Americans' mastery of technological invention. It has proposed to digest and, according to its recent five-year plan, "re-innovate" foreign technology. Chinese appropriation of Western intellectual property wipes out the U.S. advantage.

China has also disrupted Americans' advantage in capital formation and allocation. China taps its state-controlled war chest to lavish credit and capital on its favored firms. It also entices Wall Street to do so, hijacking both U.S. and China capital for state purposes.

China has disrupted Americans' advantage in a dynamic labor market as well. U.S. businesses readily hire, fire, and move employees. China turns this strength into weakness by enticing U.S. businesses to move jobs to China--roughly 2 million in the last ten years--and by condoning slave labor conditions and labor laws.

China has even disrupted Americans' mastery of free-market competition. Fiercely competitive U.S. firms play chumps to China's state-controlled companies, which receive state largesse ranging from subsidies and R&D help to below-cost loans and bureaucratic protection. One example: U.S. insurance companies in China, unlike Chinese ones, must get new branches approved one at a time, a process that can take 18 months.

Finally, China has disrupted Americans' mastery of manufacturing. It has targeted critical and strategic U.S. industries for migration to China. One stated goal: to replace foreign parts in all "core infrastructure": integrated circuits, operating software, switches and routers, database management, and encryption systems.

How does the U.S. return to winning when China so adeptly neutralizes our strengths? We must reinvent capitalism to wrest strategic advantage from China. Here are some suggestions for what I call "strategic capitalism".

Balance the budget and reduce the debt: Return spending to a level that gives us a war chest equal to China's for investing in new technologies and business models. We cannot fight strategically without restoring our financial health.

FIP Board: Create a Federal Industrial Policy Board, akin to the Federal Reserve Board, to support promising industries until they gain strength and positive cash flow. U.S. government strategists will sometimes "pick losers," but like venture capitalists, they can win by investing in high-risk, high-reward industries.

MARPA: Establish a Manufacturing Advanced Research Projects Agency. MARPA would create leading-edge factory processes in the legendary way DARPA (Defense Advanced Research Projects Agency) built semiconductors and the Internet.

Regulatory One-Stop Shops: Consolidate offices that regulate each industry. Naming one super-regulator will improve coordination, speed approvals, and enable rapid industry buildup. Don't let China's laxity and central control remain an advantage.

Portfolio Strategy: Call on the FIP Board, like a for-profit board, to monitor the U.S.'s industry "portfolio." Staff the board with strategists and former CEOs--not economists who trust the "invisible hand"-- to create a healthy portfolio. Charge the board with categorizing U.S. industries into rising stars, veteran cash cows, sectors in decline, and newborn industries. Allow strategists to nurture new stars and cash cows and guide newborns and declining industries toward stardom or retirement.

Job Production: Call on the FIP Board to target a select three or four industries with high wages for long-term job creation, such as automobiles. Protect these industries to assure a healthy base of jobs for the nation. Protecting jobs will raise the price of select goods, but the tradeoff is a strong middle class, higher consumption, and a stable democracy.

Such measures would focus America's resources on beating China at its own game. They would build our weaknesses into strengths to shift the basis of competition. They would turn neglected strengths into advantages China cannot match. And they would disrupt or neutralize many strengths of China's system. Some people say government shouldn't manage industry--it should trust the evolution of the free-market. But we have managed the birth of industries before--the space program, pharmaceuticals, semiconductors, and others. Where would we be without the DARPA-created Internet?

Saying the government can't pick winners denies history. It also ignores reality--the best private venture capitalists are unsuccessful three quarters of the time. In recent years, the U.S. government has fared poorly at managing industrial policy for lack of organization. We have let crony capitalism enfeeble us.

To win, we must to add to our repertoire of free-market tools the tools of managed capitalism. We cannot rely only on free-market policies of the 1980s and 1990s. We must learn new capabilities to beat a form of capitalism that is overwhelming our old formula for success.

Only by adapting will we stop China from turning our strengths into weaknesses--and will we make weaknesses out of their strengths. It is time to stop transferring ever more wealth, power, and jobs to the East.