11/01/2019 No. 147
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Capitalism Versus State Capitalism
By Yung-Sheng Cha
December 1, 2018

Several experts wrote about the "Thucydides Trap" in which a rising power is challenging a ruling power. In twelve of the sixteen cases in history, it ended in bloodshed. This time they are referring to the rivalry between China (a rising power) and the U. S. (a ruling power). The question often asked is: can a military confrontation between China and the U. S. be avoided?

First, China is not the second most powerful military in the world. That title belongs to Russia. Second, China will not be a military threat to the U. S. for at least twenty years (maybe thirty years). China is well aware of its limitations and would definitely try to avoid a direct military confrontation with the U. S. On the other hand, the U. S. probably would not likely to go to war with China because that would benefit Russia, its long time and traditional enemy. Furthermore, even though China only has a relatively small stockpile of nuclear weapons, it can cause devastation in the U. S. in a military confrontation. Therefore, for at least twenty years (more like thirty years), a military confrontation between the U. S. and China is not likely and the "Thucydides Trap" is not of great concern now. Of course, it also depends on the wisdom of the leaders in both countries to manage the conflicts and avoid the "Thucydides Trap". 

On the economic front, it is a whole different matter. China's overall economy is the second most powerful in the world, next only to the U. S. Since 1979, China adopted the policy of "reform and opening" under Deng Xiaoping. It is moving away from the centrally controlled system to allow some private industries and businesses to operate. But it is not a capitalist system like the U. S. A number of important and large companies are still owned by the state. Furthermore, long term planning is still the government's responsibility. Experts in the West and the U. S. named the Chinese system "State Capitalism" because it is different from the traditional capitalist system where there are very few or no state-owned companies. The core value of the "State Capitalism" is heavy involvement of the government in private industries and businesses.

State capitalism worked well for China. Its economy flourished under such a system. The transition from a totally centrally controlled system to the semi-capitalist system is also very successful. The standard of living in China increased manifold during the past thirty years. In the early period of the "reform and opening" in China from 1979 to 1992, the U. S. welcomed such a transition, mainly because the number one enemy of the U. S. was the Soviet Union. The U. S. wanted to help China to be stronger and more powerful and be on the side of the U. S. against the Soviet Union, even though China was still a non-democratic, socialist country. After the collapse of the Soviet Union in 1992, The U. S. was still willing to help China to develop its economy because many in the U. S. believed that China would eventually reform not just the economic system to a full-blown capitalist system but also reform its political system from the one-party, authoritarian system to a democratic system. However, it turns out that the one-party system in China remains intact and it still has firm control of its people, even though China continues to open up its economic system gradually. This fact disappointed many in the U. S. in the years that followed.

By the year 2000, it became clear that China's economy was growing very fast. Some policy makers and pundits from think tanks were ready to get tough on China. But soon 9-11 happened and the U. S. got involved in two major wars in Afghanistan and Iraq. Before the two wars were over, the U. S. economy was hit severely by the financial crisis of 2008. When Obama was elected in 2008, his number one priority was to save the economy from further falling into depression. By 2011-2012, as the U. S. economy was on its way to recovery, the Obama administration announced the policy of "Pivot to Asia" and initiated the Trans-Pacific Partnership (TPP). Both were aimed to contain China. Even though the Obama administration wanted to contain China both economically and militarily, it still wished to engage China economically because China contributed to thirty percent of the growth of the world economy since the financial crisis. The Obama administration continued to maintain that a peaceful and prosperous China is good for the U. S. and the world.

A dramatic change in U. S. policy came when Donald Trump was elected president in 2016. Trump wants to pursue the policy of "America First" and "Make America Great Again". This zero-sum-game policy means that a prosperous China (and other countries) is no longer good for the U. S. Trump and many experts are deeply concerned about the rapid growth in China, and they are particularly worried about the advances in high and future technologies because, in the not-too-distant future, China may exceed the U. S. both in economic output and in high technologies. The announcement of "Made in China, 2025" is particularly troublesome for the U. S. In that announcement, China specifically targeted ten future technologies such as artificial intelligence, electric cars, bio-medicine, etc. If that happens, the U. S. will most likely fall behind China and will eventually lose its hegemony in the Pacific and the world.

To prevent China from further development and advance in its economy, Trump initiated the trade war by imposing tariffs on imported Chinese goods. The official rationale given by the Trump administration is that China has a large trade surplus with the U. S. But most economic professionals know that the U. S. trade deficit is a domestic issue. It is caused by the large federal deficit and American households spending beyond their means. The real reason behind the trade war is the competition of future technologies. As Geoffrey Garrett, Dean of the Wharton Business School, wrote about the trade war: "What is really going on is not about trade; it is about who will lead global innovation in the 21st century."

If the trade war expands to a full-blown tariff war, China may soon run out of tariffs to impose on U. S. goods because there is a large trade surplus for China. But there are several non-tariff measures (such as boycotting the U. S. companies and businesses in China, devaluing the Chinese currency, reducing the holdings of the U. S. treasury bonds, etc.) that China can employ in retaliation against the U. S. Then the trade war will become an economic war. What we are witnessing now is the beginning of an "Economic Thucydides Trap", in which a rising economic power (China) is challenging a ruling economic power (the U. S.).

To prevent China from moving ahead in future strategic technologies, Trump and his economic advisors want the Chinese government to stop subsidizing their industries and the state-owned companies. In other words, the U. S. wants China to change its "State Capitalism" to a "U. S. style of Capitalism". (It should be noted that the U. S. capitalist system also subsides the defense industries and the farmers, and the U. S. government also has agencies that funds basic and applied research such as the National Science Foundation, the National Institutes of Health, and the Department of Energy). Therefore, the economic war will soon turn out to be a war between "State Capitalism" and "Capitalism".

China, on the other hand, is not likely to change its system of "State Capitalism" because it was so successful in the past thirty years. It lifted several hundred million people out of poverty. The standard of living in China continues to increase. For China, the central question is not trade but development. The average Chinese income per capita is only about one-sixth of that of the Americans. The demands of the U. S. are tantamount to cutting off China's path toward a wealthier society. To the Chinese leadership, this poses an existential threat. Beijing will not yield to the demands of Washington.

Furthermore, "Made in China, 2025" is China's future. It is part of the "Chinese Dream" to continue its economic development and wipe out poverty for all Chinese. China has no choice but to fight such a war. Imagine if China asked the U. S. to switch from "Capitalism" to "State Capitalism" or to stop its hegemony around the globe: the answer from the U. S. would be a resounding no.

In addition to the fight on innovation and in strategic industries in the future, Trump and his advisors also complained about China limiting its market to foreign companies and businesses. But the U. S. is also trying to limit Chinese investment in the U. S. and prevent some Chinese companies (such as Huawei) to operate in the U. S. Another complaint from the Trump administration is that China is forcing U. S. corporations to transfer technology if these corporations want to operate in China. This complaint is strange because if the U. S. corporations deem that the risks outweigh the benefits, they do not have to agree to the deal. In any case, these issues will also be a part of the war between "State Capitalism" and "Capitalism".

In summary, when the U. S. hegemony is challenged, Washington will do whatever is necessary to suppress that challenge. This will happen whether it is a Democratic or a Republican Administration. On the other hand, when China's development and progress towards eliminating poverty and better standard of living is threatened, Beijing will not stand idly by and yield to external pressure. China's official position is best expressed in an article by Fu Ying who is currently vice chairperson of the Foreign Affairs Committee of China's National People's Congress. In that article she wrote that "the Chinese people will stand firm against U.S. bullying over trade. There is talk about China's economy sliding as a result of the trade war. Some expect China to succumb soon. I can tell you that this is wishful thinking." In the same article, she also stated that to serve China's development goals, there is every reason for China to maintain an attitude of "constructive cooperation" with the U. S.

The "Economic Thucydides Trap" is not likely to be avoided even if some kind of agreement on trade is reached. It may last ten or twenty years. Let us just hope that the leaders of both sides are wise enough to reduce the damage to some manageable level, and the world economy will not suffer badly as a result of this irrational fight between "State Capitalism" and "Capitalism". Even more important is that both sides should make every effort to avoid turning this "Economic Thucydides Trap" into a military "Thucydides Trap".


Y. S. Cha

September, 2018

Darien, Illinois

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Yung-Sheng Cha graduated from the Mechanical Engineering Department of National Taiwan University in 1967. He received his M.Sc. and Ph.D. degrees in Mechanical Engineering from Lehigh University in 1970 and 1973, respectively. He was employed by the Argonne National Laboratory in 1974 until his retirement in 2006. While at Argonne, his research focus was mainly on different energy systems. Dr. Cha is a U. S. citizen.
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