CHINA AND THE SHIFTING BALANCE OF ECONOMIC POWER

by William R. Hawkins

In March of 1917 the British Empire captured Baghdad from the Ottoman Empire. That military campaign was part of the larger conflict of World War I, from which Great Britain emerged victorious. Indeed, London has not lost a major war in over two centuries, though as the Duke of Wellington said of Waterloo, some have been near-run things. Yet, during this same period, Great Britain dropped from the position of a global superpower–one boasting an empire that governed a quarter of mankind–to that of Europe’s third-ranked state and barely among the top ten nations worldwide.

Great Britain did not lose its position to rivals in war, but to rivals in peace. This is something that Americans savoring their current victory over Iraq should contemplate.

The twentieth century saw the tumultuous rise of several new powers within the international system as the industrial revolution, which had been pioneered by England in the eighteenth century, spread across Europe and around the world. By the eve of World War I, both Germany and the United States had surpassed Great Britain in manufacturing output. Russia was beginning to industrialize in earnest and Japan was becoming the first Asian state to follow suit. The origin of World War I lay in the East; Germany feared Russia’s potential strength once its vast resources and population were mobilized by modern science and industry.

The day-to-day exercise of world power depends on the material wealth of the major contending states. National leaders may at times lack the desire or will to play on the world stage, or they may do so incompetently. But those who lack the means to act have limited options. They cannot expect to be successful when facing those who do have the means and the skill to control events.

The twenty-first century will see the further spread of science and industry, which is the real meaning of the buzz word “globalization.” The result will be the rise of a new crop of major nations vying for their place in the international system. They will seek the power to control their destiny and to grab the largest possible share of the world’s wealth.

Foremost among these new rivals is China. At the March National People’s Congress in Beijing, retiring Premier Zhu Rongji declared that China’s goal was to build “large internationally competitive companies or enterprise groups that have distinctive main lines of business and possess their own intellectual property rights and name brands.” Beijing is investing strongly in education and is now graduating more electrical engineers than the United States. It is offering incentives to bring back home the hundreds of thousands of Chinese students who have gone to the best universities in the West to learn about leading edge technologies. And it continues to demand technology transfers from the many foreign firms that have been investing in China.

China’s embrace of capitalism is not that of the laissez-faire variety. Take the case of the steel industry. Despite the fact that there is substantial overcapacity worldwide, which has led to such massive dumping into the American market as to imperil the survival of most U.S. steel mills, the Chinese have been investing heavily in new, efficient steel-making capacity. Domestically produced steel is expected to replace imports, which have been rising to meet the demands of a growing country. But China’s leaders do not want to import anything of strategic value that they can make themselves. The ability to produce high quality hot-rolled products within China at low costs will also make the steel-using segments of Chinese industry more competitive, both at home and overseas. And, of course, Chinese steel mills are expected to flood the already saturated global marketplace with exports.

This pattern of meeting growing market demand from domestic production, rather than from the imports that adherents of the “big emerging market” thesis had predicted in the 1990s, has been seen in other areas of heavy industry as well. The large number of construction projects in China has boosted the demand for excavators. China has become one of the biggest markets for excavators, with sales of more than 17,000 units in 2002. To meet this demand, the Swedish firm Volvo announced last year the establishment of a wholly owned production facility in Shanghai’s Pudong area. For an investment of around US$15 million, Volvo will have a capacity of several thousand units per year with initial production focusing on its newest twenty-ton class B series crawler excavator.

American heavy equipment manufacturer Caterpillar has lobbied hard for detente between Washington and Beijing while exporting equipment to China for over twenty years. However, it now proclaims on its corporate website that the company’s long-term goal is:

“to be a major supplier of earthmoving and mining equipment, diesel and natural gas engines and electric power generator sets in China. Its strategy for achieving that goal includes establishing a manufacturing base in China….China’s goal of quadrupling the gross national output and establishing a ‘Socialist market economy’ present great opportunity for companies such as Caterpillar that can invest in and sell to the massive infrastructure development driving much of that growth.”

To that end, Caterpillar Xuzhou Ltd., a joint venture between Caterpillar and Xuzhou Construction Machinery Group, was established. The website says that Caterpillar is “committed to being the leading manufacturer of world-class hydraulic excavators and road building machinery in China.” Caterpillar already produces a variety of engines and chassis components in China within other joint ventures.

In an interview with Barron’s published on April 9, General Motors retiring chairman John F. Smith, Jr., said Western automotive-technology companies will be looking for Chinese partners to expand operations in the Chinese vehicle market, as well as to meet demand from U.S., European and Japanese automakers for lower-cost vehicle parts. GM, Ford and other large automakers have outlined ambitious goals to purchase billions of dollars worth of vehicle components from China.

These developments confirm the work of Professor Robert S. Ross of Boston College, who has argued that “China, unlike Japan, has the natural resources to sustain economic development and strategic autonomy….Rather than move abroad as labor costs increase–as U.S. and Japanese enterprises have had to do–Chinese enterprises, following market forces, will be able to move further into China’s interior to exploit an inexhaustible, inexpensive and relatively reliable labor force.” Indeed, at the seventh investment and trade fair held in early April at Xi’an, capital of the western Shaanxi Province, forty of the world’s top 500 companies from the United States, France, Germany and Japan attended. Contracts for over US$400 million were signed. This pattern not only strengthens China, but weakens Beijing’s economic rivals in both Asia and the United States.

While economic stagnation afflicts much of the world, Chinese industrial output has maintained strong growth for fourteenth months in a row. And in the first two months of this year, the industrial added value increased 17.5 percent over the same period last year, a record high since 1996.

In contrast, the Federal Reserve reported April 15 that total output from U.S. manufacturers fell again in February and March, continuing three years of decline. The current three year downturn–despite increased demand growth–is similar to the disastrous period from 1979-1982, which was the worst since the 1930s. American demand is being met increasingly by imported manufactures.

Official Chinese statistics show that in the first quarter, China’s foreign trade displayed strong growth. The export of machinery and electronics products, which account for half of China’s total exports, increased 42.1 percent in the first two months, 20 percentage points higher than the same period last year. The export of new and high-tech products increased 51.8 percent.

China’s trade surplus with the United States has passed that of Japan’s, and is even more one-sided as a trading relationship. That the United States buys US$2.50 worth of Japanese goods for every US$1 worth of American goods it sells is bad enough, but in the Chinese case Americans buy US$5 worth of Chinese goods for every US$1 of U.S. exports. Much of this imbalance is due to nominally American firms becoming partners with Chinese firms to build factories in China that replace factories in the United States.

Great Britain lost its place in the world by its own volition. By adopting “free trade” and a laissez-faire attitude towards the process of economic advancement, its leaders acted as if the outcome of commercial competition did not matter. American officials seem to have adopted this same attitude today. Little concern is expressed in official circles about the rise of Chinese economic capabilities even as the process is aided by the transfer of capital, technology and production capacity from the United States.

When Baghdad fell to the Mongols in the 13th century, Marco Polo wrote that a rich treasure vault was discovered in the palace. Before executing the captured Arab caliph, the warlord Hulagu, grandson of Ghengis Khan, mocked him for not having used the city’s wealth to strengthen its defenses during the years before the Mongols appeared. Will American leaders someday be mocked for having failed to defend the industrial base upon which their nation’s prosperity and security depends?

William R. Hawkins is Senior Fellow at the U.S. Business and Industry Council in Washington, DC.