Noah Smith has a new Bloomberg column that expresses worry about too much technology being transferred to China. This partly reflects a widespread concern about China stealing technology, which might reduce the incentive of inventors to create new ideas. But most of Smith’s column focuses on more legitimate forms of technology transfer, such as Chinese foreign investments and joint ventures with Western firms. Smith worries about the effects of this sort of technology transfer, and is sympathetic to the idea that the US government might want to slow this process:
Suppose a Chinese electric carmaker wants to win market share by selling cars with the best cutting-edge battery technology. How does it get that technology? It can hire some engineers, build a lab and try to develop it inhouse. It can partner with a university research lab to create it. Or alternatively, it can buy an American company that already has the technology.
The latter move might be profitable for both the acquirer and the target, but it can stifle a whole ecosystem from developing around that company in the U.S. The Chinese company will likely take the battery technology back to China with it, producing the batteries in China and sourcing the parts in China. Had the company not been acquired, it might have spawned a network of American suppliers and customers. Some of its employees would have left and gone to work for those suppliers and customers, or for competitors, or spun off their own businesses. They would have taken their knowledge of the first company’s technologies with them, where those ideas — whether protected by nondisclosure agreements or not — would combine with those of others, potentially creating whole new innovations. Instead, since a Chinese company now takes the tech back with it, that virtuous cycle will now happen in China instead, and the U.S. economy as a whole will lose out.
The beauty of information is that use by one person does not preclude use by others. I see technology transfer to China as a huge win/win for the global economy. Let’s start with the obvious:
1. Technology transfer to China is a huge win for China itself, as Smith himself notes:
China’s government can therefore be expected to take drastic measures to escape the dreaded middle-income trap — and that means acquiring foreign technology by hook or by crook.
Moving a country of 1.4 billion people from middle income to high income is a huge gain in welfare. In fairness, this will occur regardless of what policy the US adopts regarding technology transfer, but it will happen faster with a liberal regime. Some might ask why we should care about the welfare of the Chinese. I’d ask people to first consider why we should care about the welfare of anyone outside our friends and family. The answer is simple; it’s the right thing to do.
2. Technology transfer is also a huge win for the US, in several different ways. The direct advantage is that the US can then concentrate on what it does best—creating new ideas, and then earning profits from selling those ideas to China. China concentrates on what it does best, which is manufacturing goods like batteries, and uses the revenue to buy more new ideas from the US. That’s the standard argument for free trade. It’s true that one can create models involving assumptions such as increasing returns and agglomeration, where “strategic trade policies” can produce gains for the domestic country, but even the developers of those models (such as Paul Krugman) are often skeptical of whether real world governments have the ability to pick the appropriate sectors to protect. And again, there’s a big hurdle for protectionists to overcome, as the direct effect of investment barriers is negative.
3. I think that Smith also underrates the advantage to the US of a rich China. Let’s start with economics. If you look at where American companies earn their biggest profits, it’s highly skewed toward high-income economies. Thus the Netherlands provides a bigger market for US products than the much more populous Tanzania. Per capita income is a huge factor in determining the size of the market for the products of companies such as Apple, Disney, GM and Coke.
But that’s not all. China is not just much bigger than the US, it’s also more culturally homogeneous (at 92% Han). And that has resulted in a situation where, despite its size, China has a comparative advantage in a fairly small set of sectors—particularly mid-level manufacturing. In contrast, the US has important advantages in a wide range of sectors, including food, energy, high tech equipment, software, entertainment, consulting, finance, military hardware, commercial airliners, capital goods, and many others. A market with 1.4 billion affluent Chinese would be a mind-boggling fertile playground for American companies to sell into. We should welcome a rich China, even if we are evil people who don’t care about the welfare of 1.4 billion fellow human beings.
4. A rich China is also likely to be a more peaceful China. In recent decades, wars are increasingly less likely to be fought in rich areas. Think Eastern vs. Western Europe, or Latin America vs. North America, or Japan vs. South Asia. WWII convinced rich nations that they had too much to lose from modern weapons. That doesn’t mean that things can’t swing back the other way (as during 1914-45), and certainly a rich China would pose a greater military threat to Taiwan. On balance, however, the evidence points to wealth making the world a more peaceful place, at least in the era since the invention of the atomic bomb. My guess is that if China ever decides to put the screws on Taiwan, it will be via economic warfare, not military. Also note that Taiwan would probably be more comfortable joining a high-income mainland China than a middle-income China. And finally, transition to democracy is extremely highly correlated with income, and I emphasize “extremely”. Again, that doesn’t prove that a rich China would become democratic, but it’s certainly a more likely outcome than for a middle-income China.
PS. Speaking of China, this is just the tip of the iceberg:
The tariffs imposed by President Trump have claimed more jobs, this time at a consumer-electronics manufacturing plant in South Carolina.
Element Electronics blamed tariffs on Chinese imports for its decision to shut down its manufacturing facilities in Winnsboro, SC, a town located about 30 miles north of the state’s capital. The plant, which makes Element TVs, will maintain a skeleton crew of eight workers, as it hopes the shutdown will be temporary.
READER COMMENTS
ant1900
Aug 10 2018 at 1:13pm
Prof Sumner, since Jan 19 (market close before first tariffs were announced), here’s some stock market performance:
US total stock market (VTI) up 1.4%
International stocks ex-US (VXUS) down 12.3%
China (GXC) down 16.4%
Performance really decoupled in mid June when the US escalated the size of tariffs on China and China formally retaliated.
The market seems to be saying trade conflict will be much worse for China and the rest of the world than for the US. Do you agree with that interpretation?
David Henderson
Aug 10 2018 at 1:41pm
Excellent post, Scott.
Don Boudreaux
Aug 10 2018 at 3:30pm
Scott: I join David in applauding the excellence of this post of yours.
I comment here only to make more explicit a point in your post that deserves to be further spotlighted. It’s this: there’s a tension between those who worry that Chinese theft of American intellectual property dampens Americans’ incentives to create more innovative ideas worthy of being protected as intellectual property, and those who oppose the voluntary sale or transfer of American intellectual property to the Chinese. For government to restrict us Americans from selling or voluntarily transferring our intellectual property to the Chinese would be for government to dampen our incentives to create more innovative ideas worthy of being protected as intellectual property – exactly the same negative effect that is believed to occur if, when, and to the extent that the Chinese steal Americans’ intellectual property.
Consistency requires that those who fear that Americans’ inventiveness is dampened by Chinese theft of American intellectual property should be among the most ardent opponents of attempts to prevent the voluntary sale or transfer of such property from Americans to the Chinese.
P Burgos
Aug 10 2018 at 4:59pm
How is it that people come up with new ideas? I suspect that a lot of it is learning by doing, which if true, would support Mr. Smith’s belief that industry agglomeration is an important driver of innovation. Also, the argument against technology transfer sounds like it is also an argument against intellectual property as well, or am I misunderstanding?
Scott Sumner
Aug 10 2018 at 5:08pm
Thanks David.
Don, That’s an excellent point; I hadn’t thought of that.
Burgos, Yes, agglomeration does help drive innovation, but strategic trade policies are very unlikely to have much impact on agglomeration. Silicon Valley and Hollywood aren’t going anywhere.
Philo
Aug 11 2018 at 8:12am
Excellent post (and excellent comment by Don Boudreaux). I won’t link to it on my Facebook page, because my Facebook friends are already getting the impression that I’m just a shill for Scott Sumner).
gwern
Aug 10 2018 at 9:39pm
Each one of these arguments would appear to be fully applicable to ‘transferring’ IP to other Americans as well, and fully general arguments against having IP at all.
Mehparapatti Heparwar
Aug 11 2018 at 6:21pm
[Comment removed for supplying false email address. Email the webmaster@econlib.org to request restoring your comment privileges. A valid email address is required to post comments on EconLog and EconTalk.–Econlib Ed.]
E. Harding
Aug 12 2018 at 2:28pm
But are they increasingly less likely to be fought by rich countries? Once you account for Europe being a plaything of the U.S., no. A larger economy increases a country’s military capability, and, thus, its willingness to engage in warfare in areas a lower level of military capability would not have permitted it to. Such as Afghanistan, Bosnia, Syria, Niger, or Iraq.
That’s just not true. China’s economic complexity of exports is between that of France and Belgium -hardly home to “a small set of sectors”.
http://atlas.cid.harvard.edu/rankings/
Russia is a democracy. So is Georgia. So is Turkey. So is America. So are Pakistan and India. So, in some respects, is Iran. So is Israel. Democracy is not a wonder drug for peace.
As I see it, a richer China is a more powerful China. A more powerful China is a good thing for the U.S. in the short term (because U.S. foreign policy is generally hostile to the U.S.’s own benefit), but a bad thing for the U.S. in the long term (think of the day when China imposes sanctions on U.S. companies because it does not like its leadership).
Jon Murphy
Aug 13 2018 at 8:02am
Yes. Warfare between countries has been falling.
Not necessarily. A larger economy may increase military capability, but it also increases the costs of war, especially if one is going to war with a trading partner (this comment also applies to your later comment regarding the growth of China).
E. Harding
Aug 15 2018 at 2:06pm
<blockquote>Yes. Warfare between countries has been falling.</blockquote>
I mean, as a percentage of total wars.
<blockquote> A larger economy may increase military capability, but it also increases the costs of war</blockquote>
Increases the cost of war in nearby regions, decreases it in far ones.
Nick Ronalds
Aug 13 2018 at 2:15pm
Yes, excellent post, and follow-up from Don. When a company is sold to China, along with its technology, its owners can either start a new company to compete with the one they sold (if there’s a non-compete, perhaps after a lag), or move on to other opportunities, perhaps creating newer technologies. And if the Chinese are able to use the technology to sell to Americans (and others, including Chinese) more cheaply, so much the better. I’m old enough to see the glaring parallels between the anti-China rhetoric of today with the anti-Japanese rhetoric of the 1980s. None of the dire consequences of selling assets to the Japanese came to pass (“they will end up owning America!”). In fact, American innovativeness accelerated, while Japan fell into relative stagnation. And of course, the Japanese also threw money away on trophy assets like golf courses and the Rockefeller center, which, strangely enough, is still sitting in New York City, where it’s always been.
BC
Aug 13 2018 at 10:53pm
The Chinese “forced” IP transfer rules seem to me like a non-tariff trade barrier. Yes, companies can refuse if they don’t think access to the Chinese market is worth it, but that’s like saying the minimum wage is ok because employers can just not hire workers if the minimum wage is too high. If one opposes tariffs, then shouldn’t one oppose “forced” IP transfer as a non-tariff trade barrier?
“We should welcome a rich China”
We should welcome rich Chinese *people* but not a rich, expansionist, totalitarian Chinese *government*. Scott concedes that a rich China is a greater military threat to Taiwan (and actually the rest of the Indo-Pacific) but then just hand waives it away. The Chinese government is like an organized crime mob that has taken over a country. We shouldn’t penalize the Chinese *people* and should engage with them commercially, but we should still recognize that part of their income will be taken by the Chinese government to build advanced weapons, just like the Mob uses extortion money to buy guns. We also know that the Chinese government is not above using its power in China to compel even American airlines and corporations to use their *US* websites to promulgate China’s propaganda messages [https://www.nytimes.com/2018/07/25/business/taiwan-american-airlines-china.html]. (At least the Russian government uses paid advertisements instead of compelled speech.) If the US government were to use its regulatory powers over firms to compel them to disseminate pro-Trump messages on their websites, I think that we would all recognize that to be compelled speech contra the First Amendment. An unfortunate reality is that the larger the fraction of global GDP in China, the greater the global regulatory reach of the Chinese government. Again, none of this dispositively precludes trading with the Chinese people, but we should at least recognize geopolitical reality.
Nazi Germany and Imperial Japan were both wealthy countries. One could argue that better pre-WW2 policies towards Germany could have prevented the Nazis from taking power. But, the Communists are already in power in China. Conditional on the Nazis taking power in Germany, arguably anything that increased Germany’s wealth before WW2 came back to hurt us during WW2. The usual economic case for trade, which only considers people and firms, does not address the geo-strategic issues between free nations and authoritarian governments. As China has become wealthier over the 30 years since Tiananmen Square, they have not become more democratic nor less hostile to their neighbors. Just the opposite, they have become more confidently aggressive. While it’s possible that trend could change, we haven’t seen any evidence of it so far.
NateF
Aug 14 2018 at 1:46pm
Of course I agree with these arguments – but they all assume China will one day be a force for good. I would bet that yes, they will be. But, knowing what we know now about certain regimes in history, it would have been optimal to cut off exchange much earlier.
My point is, “all is well that ends well.” If we do all this, allow more exchange, and China ends up throwing its weight around more and more adverse to our interests (hopefully our interests are democracy and freedom).
I give you a not so unlikely alternative outcome. China becomes a stable rich one party state that has tyranny figured out for the 21st century. So much of what hobbled the enemies of freedom as of late was they couldn’t figure out the late 20th century tech. Internet hobbled efforts to contain info. China has that figured out. They could export that.
They could be a major source of an alternative view of wealth that we so arrogantly assumed could not exist: a rich country where people are complacent with their material wealth and ignore their glaring lack of freedom because none of those things really matter to them.
Todd Kreider
Aug 14 2018 at 1:53pm
I’ve been skeptical of the “dreaded middle income trap” but the article Noah Smith linked to clarifies it. Out of 106 middle income countries in 1960, only 11 had “escaped” after a few decades. I then saw an Economist article noted that “middle income” has a huge range – from 5% of U.S. GDP per capita to 45%.
China’s economy did slow down after the recession just as many countries did even though it is still growing at 6% to 7%.
Japan slowed down around 1974 when it reached the same GDP per capita, $17,000 – where China is today.
Walter Sobchak
Aug 14 2018 at 5:24pm
“A rich China is also likely to be a more peaceful China.”
In 1910 optimists said that a rich Germany is also likely to be a more peaceful Germany.
The era since the invention of nuclear weapons has been the era of the Pax Americana. The world has been peaceful (sort of) because the US was willing and able to be a dominant power that suppressed international conflicts. It is a highly unusual situation in world affairs. Don’t expect it to last.
Read Thucydides.
Pray for peace, prepare for war.
Michael Rulle
Aug 15 2018 at 2:53pm
It never occurred to me that ethnic uniformity (92% Han) could ever have anything to do with the limits on the number of businesses/industries one could have a comparative advantage in. Is there any economic or sociological evidence of his? There are 8 distinct languages, according to Wikipedia, which are as different from each other as German is to English. Plus some 300 “dialects”. Of course, similar to how English is the dominant language of the world for business, etc., so is Mandarin (or “standard Chinese”) in China. I claim no unique knowledge of Chinese Culture, (which is obvious), but your assertion of equating Han with comparative advantage seems unsupportable by any theory I have ever heard of.
I have always had an intuitive belief (because that is all it has ever been) that increased wealth (by production, not theft) is good for everyone. So, to the extent, your arguments about technology transfer creates the ability to maximize or optimize comparative advantage, your position is very persuasive. And one does have to feel some amazement that 60 years after that horror show of Mao left this planet, that China has advanced so greatly.
But I cannot help but be skeptical about China. They have significant restrictions on taking capital out of the country. What are they afraid of? Obviously something. The Chinese have a 5000 year history of great ups and downs. There is cultural distrust. The current “dynasty” was founded by Mao in 1949 and is still called the People’s Republic of China. My sense is there is always fear that collapse could be just around the corner (as they are everywhere, except they have experienced it) as they view History through an enormous lense of instability. The rest of the world wants to invest there, but China is not trusted. That is their fault.
I do not know why Xi felt the need to take power, (with Mao like tributes to his “great theorist” abilities) but it is clearly a bad sign. I do agree that a wealthy (and more constitutionally lawful) China would be a great boon to mankind. I just do not think they have the ability to not fall far short of their potential. Do they really need those fake islands? Paranoia. Too many peasants to absorb. They are afraid they are running out of time (they are). They need whatever the Chinese word for lebensraum is as their need for food and natural resources (high burn rate) become increasingly critical. They do not trust the outside world and vice versa. They are not Japan. We conquered Japan who then became a great ally. Sometimes I think China will eventually feel the need to do some conquering of their own. I predict nothing. I just do not a clear path for China.
I certainly hope they can develop more comparative advantages than your “Han theory” suggests.
pecg
Aug 16 2018 at 10:38am
As a Chinese, I have only given an explanation after reading your article. You have been bought by the Chinese government.
China is not a normal nation state at all, but a revolutionary government based on military power.
The wealthy Chinese government will only strengthen his authoritarian alliance to ensure eternal rule.
Sorry for my bad english.
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