The Best Way to Compete with China Is to Free the Economy

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Published : March 12th, 2018
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As things stand, China holds around 20 percent, or $ 1.2 trillion, of outstanding US credit market debt. This is the result of decades of “symbiotic interaction”, if one follows the hidden message that is embedded in the neologism “Chinamerica”: Americans consume more goods from China than they export to China, and the Chinese are willingly financing the US trade deficit with their “over-savings” by holding dollars and US dollar-denominated debt. In 2017 alone, it amounted to $ 375 billion.

For about 25 years, the narrative has been that China – with 1.4 billion people the largest and by GDP the second largest country in the world – will increasingly integrate itself into the global division of labor, democratize itself, and adopt the Western world’s rule book. This may explain why the West, on more than one occasion, has been turning a blind eye when the rulers in Beijing trampled on human and property rights. But such an accommodation won’t pay off. Especially so because “Chinamerica” is a delusion.

China is not about to adopt the West’s brand of social-democratic socialism. It adheres to an autocratic, totalitarian system. In March 2018, the Communist Party is likely to abolish a constitutional clause designed to prevent the rise of a new Mao Zedong enabling President Xi Jinping to stay in office for as long as he pleases. Since he seized the reins of the Communist Party five years ago and “purged” the apparatus, repression and state control have intensified in China, and so has China’s self-assertion on the international scene.

With an Orwellian “point system”, China’s rulers want to force every citizen to socialist-virtuous obedience. Criticizing the government becomes life-threatening. Such a system of total surveillance is what China’s “state capitalism” actually requires. Under state capitalism, the state, or more accurately, its ruling class, formally preserves the private ownership of the means of production. In fact, however, it is the state that effectively determines who is allowed to do what, how, and when with their property.

How powerful is state capitalism?

We know from sound economics that socialism – or in other words, public ownership of the means of production – cannot function: economic calculation to the attempted degree is impossible, and chaos and poverty are the inevitable results. Under state capitalism that has access to international markets, however, things are somewhat different. This scheme may well go on for quite a while and even reach some high-flying planned goals. China’s stunning growth performance in the last decades bears witness to this theoretical assessment.

This success doesn’t come about naturally, though. China keeps domestic wages and its exchange rate artificially low. It improves its competitiveness in international markets at the expense of the standard of living of its people. China also attracts foreign capital, giving firms from all over the world access to its huge domestic market. This, however, comes at a price: foreign firms are obliged to operate through joint ventures with Chinese companies, thereby having to hand over expertise and knowledge to them.

The international corporate world has – voluntarily, perhaps with teeth gnashing – agreed to this deal, and has moved production and employment to China. Now we are facing the backlash coming. In the US, people increasingly consider these trade practices to be “unfair”. It is a case in point that US President Donald J. Trump calls for imposing import tariffs on steel and aluminum. There are even voices talking about China "engaging in 'economic warfare'" against the US, doing heavy damage to the American working population.

In this increasingly heated debate, it is essential to come up with a sober diagnosis of the causes of the conflict. From a sound economic viewpoint, it is quite obvious: The states and their interference with free market forces are to blame. China does so quite ’blatantly: China’s state capitalism is, without doubt, a full-blown assault on its own people’s and entrepreneurs’ freedom to choose and produce, and it also corrupts the international allocation of capital and labor.

The US is also to be critiqued. High corporate taxes, heavy regulation, bad trade deals, an ever-rising amount of government debt, an unsound monetary system - just to name a few factors - increase the incentives for productive capital to move out of the US and into other regions of the world – as firms attempt to secure higher returns on capital and diversify risk. The consequences of these US policies have been, as people increasingly realize, to the disadvantage of the US’ very own economic prosperity.

The effective response for those who see unfair practice on the part of China would, therefore, be: dismantling, deconstructing the state (or, even better, abolish it altogether). It will lead to lower taxes and less regulation, boosting savings, investment, and thus economic prosperity. The politically-induced incentive for companies to move production and jobs abroad is reversed. Capital and labor return go to the most suitable places – which are predictably those where the state is the smallest, and the least interventionist.

But what if China continues its international shopping spree, acquiring further productive capital in key industries? Under free market conditions, such concerns would be unfounded. If China buys a foreign company, such an investment only pays off if the company is managed properly and continues to serve its clients. Otherwise, the firm’s profit will go down and, if management cannot turn things around, it’ will go out of business. Meanwhile, the seller of the company can invest his proceeds to buy, or build up, attractive companies.

Protectionist measures and “economic nationalism” will not solve the problems their supporters hope them to do. State interventions will not achieve their goals, but bring about a state of affairs that is less desirable than the situation that they were meant to alter. For instance, higher tariffs on import goods may make foreign goods less price competitive, which, in turn, also means higher prices for domestic producers and consumers. Production and economic prosperity will be restricted, and in the end, people are worse off than before. 

Throwing a wrench in the works of the international division of labor is a rather dangerous thing to do: the smooth functioning of the international division of labor is at the heart of peoples’ economic prosperity. If a state does not play by the rules of the free market (and, unfortunately, none of them does), the truly wise reaction for all other states is to unleash free market forces – that is improving the conditions of doing business within its own borders – rather than to retaliate with interventionist measures. 

Scaling back the international division of labor would also alienate people and thus increase the risk of more conflicts. If people from different countries and cultures come together and join the international division of labor, they naturally form a mutual interest in peaceful cooperation. In other words: Free markets are a recipe not only for prosperity but also for peace. Ludwig von Mises, as early as 1919, put it succinctly: “Whoever wants peace among nations must seek to limit the state and its influence most strictly.”1

That said, the term “Chinamerica” is truly misleading: States are not benefactors, and the cooperation between them is not for the benefit of the general public. States (as we know them today) are the problem, not the solution. If the US and China continue to pursue interventionist measures rather than rely on free market forces, it could easily result in a financial and economic crisis, under extreme circumstances even in a military confrontation, severely testing the very foundation upon which our prosperity rests.  

  • 1. Mises, L. v. (1983 [1919]), Nation, State and Economy, p. 124.


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Thorsten Polleit is Honorary Professor at the Frankfurt School of Finance & Management.
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