US vs. China: History's Fiercest Rivalry and a Deeper Look Into the Chinese System
Why China will get its way with the West, whether the West likes it or not
Former Assistant Secretary of Defense and author of Destined for War Graham Allison recently called the US-China relationship "the fiercest rivalry1 history has ever seen".
Underlying this rivalry are two competing, highly differentiated systems.
The American free market system allows entrepreneurs to do as they see fit and for the market to reward them accordingly. Every 4-8 years, the federal government switches political parties, and in turn, its policy directions change. The executive branch's power is limited by the legislature and courts when the president is in power.
As a result, entrepreneurs are generally free to pursue their goals without worrying much government involvement or interference.
On the other hand, the Chinese state capitalist system harnesses the profit motive to help achieve the interests of the state. The central government is ruled by a president with absolute power. Policy directions are set years in advance and altered only in the face of changing conditions.
Munger’s folly
In October 2021, Charlie Munger's Daily Journal had invested 18% of its portfolio in Alibaba stock, at a cost basis of between $180 and $200 per share. By the end of Q1 2022, Munger had sold half his stake in Alibaba at an average price of $116/share.
As of Oct 2023, Munger still owns the other half of his original stake. BABA stock closed at $85/share on Oct 9, 2023, so he is down more than 50% on his original purchase of Alibaba stock.
What did Munger get wrong?
In October 2021, fellow Alibaba investor Tom Hayes commented, "You can now pay less for Alibaba than it was when the company was less than a third of its current size. And it will be tough to find one billion users elsewhere. And that’s why Buffett and Munger are the best investors around."
In a free market system with judicial independence, companies are valuable to the extent that they have durable competitive advantages or in Buffett's parlance, moats.
Alibaba totally fit the bill here, as the #1 e-commerce company in the most populated country in the world (at the time), whose stock had fallen since 2020 even though revenue had continued to rise.
Alibaba was a fully logical investment for Munger. He'd spent his entire life investing in a free market system with judicial independence (USA), so Alibaba's huge competitive advantage and wide moats made it the perfect investment.
But in a state capitalist system, entrepreneurs are rewarded to the extent that the state sees their actions as beneficial to the country's greater interest.
No amount of moats or competitive advantages can withstand the opposition of an authoritarian central government that has come to believe a company's dominance is not in the country's interest.
Was Jack Ma too outspoken? Or did Chinese big tech get too powerful for the Party to tolerate?
The media painted Beijing's crackdown on tech as 1) a reaction to Jack Ma's critical speech at the Oct 2020 Shanghai Bund Summit and as 2) a form of antitrust since Tencent and Alibaba/Ant had gotten too big, powerful, and monopolistic for Beijing to accept. Even Munger criticized Ma’s arrogance.
In Nov 2021, Bloomberg wrote:
China’s government kicked off a sweeping crackdown on its most powerful corporations a year ago.
The campaign that started with Ma’s twin giants—Ant Group Co. and Alibaba Group Holding Ltd.—last November soon spread to more companies like Tencent Holdings Ltd. and Didi Global Inc., as Beijing stepped up oversight on everything from antitrust to data security and wealth distribution. The crackdown triggered a selloff that, at its most extreme, erased $1.5 trillion from Chinese stocks, which experienced wild swings with every new government probe, rule and warning.
But there are several powerful monopolistic and oligopolistic companies that Beijing has absolutely no problem with and even actively supports. Just to name a few and their industries: CATL (batteries), SMIC (semiconductors), Huawei and ZTE (telecom equipment), BYD (EVs), DJI (drones).
Beijing doesn't have a problem with monopolies. It has a problem with companies and industries that don't expressly advance its national interests.
Dan Wang put Beijing's perspective best in his 2019 letter:
I find it bizarre that the world has decided that consumer internet is the highest form of technology. It’s not obvious to me that apps like WeChat, Facebook, or Snap are doing the most important work pushing forward our technologically-accelerating civilization. To me, it’s entirely plausible that Facebook and Tencent might be net-negative for technological developments. The apps they develop offer fun, productivity-dragging distractions; and the companies pull smart kids from R&D-intensive fields like materials science or semiconductor manufacturing, into ad optimization and game development.
Beijing doesn't want talent and resources going into Internet companies that don't help the country strategically in the long run. It wants hard tech that will help the country gain an advantage over the West.
The government's policies are beginning to be reflected in employee salaries. Recently, pay cuts in traditionally high-paying industries like finance and consumer Internet (40-50%) have been 10 times larger than pay cuts in electric vehicles, batteries or solar and wind power (4-5%).
The importance of industrial monopolies to Beijing
Beijing’s primary goal for the Chinese economy is to be TSMC x 100. The entire world relies on chips made in Taiwan by companies like TSMC for its modern way of life. The island manufactures nine out of 10 of the world’s most advanced chips.
Beijing wants China to be equally irreplaceable for the rest of the world because the more irreplaceable China is, the more easily Beijing can achieve objectives the West opposes.
As the world’s foremost and largest manufacturing cluster, i.e. the factory of the world, China’s primary comparative advantage is hardware, and what Beijing most wants are industrial monopolies like TSMC.
Here are just two industrial monopolies China has today: solar, batteries + EVs.
1) Solar
Today, solar + batteries ($46-102/MWh) is either cheaper than or cost competitive with other baseload sources of energy, including natural gas ($39-101/MWh)—the top electricity source in the US. Solar + batteries is far cheaper than quick response gas turbines ($115-221/MWh), which are turned on during spikes in electricity demand.
Through being able to provide power around the clock, solar + batteries enable a complete replacement of fossil fuels, particularly in the sunniest parts of the world, including the United States, Southern Europe, and South Asia.
Unsurprisingly then, solar has been the fastest growing source of electricity since 2016, and when it comes to new power plant construction, batteries have surpassed natural gas.
Two-thirds of all investment in renewable energy is solar—2x all other renewables combined.
Where then are all these solar panels manufactured? China.
To be precise, 70-90%+ of solar modules, wafers, panels, and polysilicon are made in China.
This means the West relies on China for its energy transition and meeting its climate goals. And batteries, as we'll see below, are similarly monopolized by China.
2) Batteries + EVs
China has majority share (up to 80%) in most material processing and manufacturing of battery cell components, battery cells, and EVs.
Bans on fossil fuel vehicles, set to go in effect as early as 2030, means that the world must rely on China when it comes to EVs and the batteries that go into them, as well as the solar panels and batteries used to power the grid.
As a point of comparison, China's share of solar and battery manufacturing capacity today (60-80%+ for key components) far exceeds OPEC’s share of oil production during the 1970s energy crisis (~50%), which wreaked havoc on the West.
China’s dominance in solar and batteries today, combined with its position as the world’s manufacturing superpower, means that the country has more leverage over the West than OPEC ever did.
In October 2023, California governor Gavin Newsom visited China, even meeting with President Xi, to focus on climate policy collaborations and bolstering ties between China and California.
It’s testament to China’s immense advantage in renewables2 that the governor of the US state with the world’s foremost technology industry is looking to China to collaborate.
China can increasingly replicate the capabilities of California’s tech industry with its own homegrown companies: Apple (Huawei), Google (Baidu), Facebook (Tencent), Tesla (BYD), even Nvidia (Huawei, Biren). But California lacks Chinese capacity in solar, batteries, etc., and must rely on China. In other words, Americans make the profits while China has the power.
Why is China so far ahead?
The short answer is 1) China’s industrial policy and 2) China’s large domestic market.
Supply
1-2 decades ago, with solar and EVs, Beijing spotted an opportunity leapfrog fossil fuels and combustion engine cars. The government heavily supported companies in these emerging industries, offering cheap loans and land to factories.
It created a system to reward manufacturers of clean cars (new energy vehicles) while punishing manufacturers of fossil fuel cars.
China introduced a dual-credit system for the auto industry in 2017, which awards points for making clean cars and penalties for those with high fuel consumption. Cars from producers with negative scores may be taken off the market. To avoid punishment, manufacturers can buy credits from rivals with positive scores, like Tesla Inc. or BYD. It can get expensive. State-owned Chongqing Changan Automobile Co. lost 4,000 yuan in profit for each car sold in 2020 as it bought credits to avoid the penalty.
To ensure the growth in EVs benefited Chinese manufacturers, EV buyers are only eligible for subsidies “if the battery was made by a Chinese company.”
Demand
At the same time, Beijing created huge incentives for the Chinese public to switch to EVs.
National subsidies reimbursed EV Buyers with as much as US$8k.
EV sales are not subject to the 10% tax on cars until 2025.
Fossil fuel cars are subject to a license plate lottery or auction while EVs can get a green license plate much more easily.
Due to state subsidies, China has more charging stations than the rest of the world combined.
The massive buildout of EV chargers, ahead of demand, helps to remove one primary reason why consumers continue to prefer fossil fuel cars over EVs: range anxiety.
A vast, mostly unused, EV charging network prevents embarrassments like the US energy secretary’s team using a gas car to block an EV charging port and getting the police called on her staff during their 620-mile (998 km) EV road trip.
Home court advantage
As a result of China’s strong supply and demand incentives, globally, 58% of EVs and more than half of solar panels are sold and installed in China respectively.
Solar and EVs are just two examples of how China has expertly used the scale of its massive domestic market to create demand for its homegrown companies so that they have vastly more capacity to compete globally compared to Western competitors.
China's economy hasn't collapsed—it's transforming
The Western media keeps talking about how weak China’s economy is today.
2010s property bubble and early 2020s crash
These woes stem primarily from a crash in real estate, which was built to satisfy the public’s rabid demand. The Chinese saw housing as a much safer investment than stocks and bonds and sought to put nearly all their wealth into housing, believing “the notion that China’s property prices could only go up”.
This irrational demand for housing fueled a massive speculative property bubble throughout the country starting in 2008.
China’s housing became completely unaffordable for the middle and working class, particularly in Tier 1 cities, where the median home price was more than 40x the median annual household income.
Towards the late 2010s, Beijing grew increasingly concerned about housing unaffordability. In 2017, President Xi emphasized, “houses are built to be inhabited, not for speculation”. The government unveiled a raft of measures to cool the market.
Today, that housing bubble has finally popped, with the fall of Evergrande and default of Country Garden—two Chinese property giants.
Shifting to Manufacturing
Starting in 2020, Chinese bank loans shifted away from the now struggling property sector and toward manufacturing.
Beijing is in the process of transitioning China's economy away from residential real estate (and to a lesser extent, service sectors like finance and consumer Internet) and going all in on its advantage as a manufacturing superpower with nearly 30%3 of global manufacturing—1.7x larger than #2 USA.
China is the only country in the world with every single industrial category in the United Nations industrial classification. It is the world’s factory, and it fully intends on making even more of the goods the world relies on.4
Beijing’s shift in economic focus has already significantly impacted the two industrial monopolies I mentioned earlier.
Solar: 5x growth in solar cell manufacturing since 2018
EVs: 8x growth in "new energy vehicles" (i.e. EVs) since 2020
China has already built enough solar panel factories to supply the entire world’s needs. It has built enough auto factories to make every car sold in China, Europe and the United States. And by the end of 2024, China will have built in just five years as many petrochemical factories as all of those now running in Europe plus Japan and South Korea.
This shift in China’s economy from real estate and services to manufacturing will involve a lot of short term pain and adjustment. For one, young people don’t want to work in labor intensive jobs in factories, even electing to deliver takeout and goods instead.
A combination of higher wages and greater automation will likely solve this issue over time. China today already has more industrial robots than the rest of the world combined.
Greater automation allows backbreaking blue collar work to transform into mentally stimulating white collar work, making factory jobs more appealing to young people.
In October 2023, Beijing removed all restrictions on foreign investment in the manufacturing sector, a sign of just how much the government values the strength and competitiveness of the country as a manufacturing superpower. It is willing to sacrifice national security and control in favor of creating a stronger domestic manufacturing base.
Capitalism, Beijing-style
When evaluating an industry or company, the first question the CCP considers is whether the industry’s or company’s success will increase the country's ability to assert its agenda in the face of Western opposition.
If so, that industry will be the beneficiary of generous state support for suppliers and subsidies for consumers. If not, watch out for government crackdowns and increased regulatory oversight.
The more reliant the West becomes on Chinese companies and the harder it is for the West to wean itself off of Chinese products5, the more easily Beijing can assert itself in the future.
This post only went into detail regarding two industrial monopolies (solar, batteries + EVs), but there are several more in China, including but not limited to commercial drones (81% market share), legacy semiconductor chips, and rare earth minerals.
In fact, Beijing even has a specific term for the type of company it wants to foster: “category champions” (单项冠军企业).
“Category champions”
In her 2023 report titled “Little Giants, Single Champions”,
went into detail on “category champions”.To be considered a “category champion”, a Chinese company must rank in the top 3 companies by global market share in its specific niche.
As of 2023, China has more than 600 “category champions”, more than triple its 2016 goal of 200.
Examples of category champions:
Xi’an LONGi Silicon Materials: 46% global market share in silicon wafers, used in all semiconductor chips.
Shanghai Quectel Wireless Solutions: 38% global market share in cellular modules, necessary for cars, drones, smart factories, robots, and power grids.
GRIPM Advanced Materials: 38% global market share in copper-based metal powders, used for 3D printing.
Given this focus on cultivating industrial category champions, it’s no surprise that prime US defense contractor Raytheon can't easily find alternative sources for components made in China. The top US fighter jet, the F-35, relied on a Chinese component for several years. In other words, even in highly sensitive industries like defense, America is reliant on its primary geopolitical rival.
All of this adds up to massive Western dependence on China.
US vs. China
The US free market system maximizes 1) wealth for entrepreneurs and investors who most profitably serve the market and 2) tax revenue for the state, in that order.
The Chinese state capitalist system maximizes 1) power for the state and 2) wealth for entrepreneurs and investors who advance the interests of the state, also in that order.
To the Chinese people, Beijing's philosophy is best articulated by John F. Kennedy in his inaugural speech: "Ask not what your country can do for you — ask what you can do for your country."
When comparing the USA and China, the US is undoubtedly richer, with a stronger economy and greater wealth. The country has military bases around the world, the ability to project power globally, and is involved in conflicts far from the United States, e.g. Ukraine, Afghanistan, Syria, Libya, Yemen, Iraq, etc.
But China has much tighter collaboration between the public and private sector, so the state is much more effective at achieving its objectives.
You don't have to look much further than the fact that the world's richest society with more than 10 million people, with a per capita GDP of $92k, and the world's 5th largest economy, California, does not have high speed rail despite decades of planning and construction, whereas Laos, a poor, landlocked country in Southeast Asia with a per capita GDP of <$2k, has one.
The key difference is industrial policy
“The US has an industrial policy. Here’s the policy: We don’t have one,” says Jeff Chamberlain, who spent more than a decade at Argonne National Laboratory trying to commercialize battery tech before starting a venture capital firm in 2016. “I’m not saying we should become socialist or communist, but other countries that have decades-long industrial policies, they’re gonna eat our lunch.”
Due to policy changes from administration to administration, the US has no consistent industrial policy. Unsurprisingly, the country often fails to nurture breakthrough industries in hardware and leaves nascent companies to the whims of the free market.
In other words, the USA has more resources, but China uses the fewer resources it has much more efficiently and effectively when it comes to achieving its national interests.
China's top imperative is to be able to achieve objectives that aren't "approved" by the US-dominated "rules-based order"6.
From that perspective, China has done a great job of ensuring the country will be able to stand up to the USA on the issues that matter to it most in the future.
Proactively directing its economy and people to achieve its national interests by following a consistent industrial policy is the best way, perhaps the only way, for an emerging power like China to stand toe to toe with the US and gain an equal seat at the table with the world's hegemon.
Unlike the world's rich, developed superpower (USA), a relatively poor, developing superpower with limited resources like China cannot afford to have groups within its own borders working against the national interest, so it uses its authoritarian system to support those working in favor of the national interest and oppose those working against it. It is grand strategy at its finest.
One of the best examples of the growing US-China rivalry are Western allegations of a Uyghur “genocide”. In 2023, Singapore’s former Minister for Foreign Affairs George Yeo noted, “no Muslim country today has condemned China on the Xinjiang policy.” By contrast, several Muslim countries have loudly condemned Israel’s bombing of Gaza, which the US fully supports.
There are increasingly questions about this dire narrative about Uyghurs that Western media continues to push. Is it really so bad, or is this a coordinated Western campaign, moving in “near absolute synchronicity”, to discredit China?
China’s rollout of renewable energy generation capacity exceeds the rest of the world combined and is forecast to grow significantly in the future.
The US-based Center for Global Development predicts China’s share of global manufacturing output could rise to 43.7% in 2050.
The director of China’s top economic planner expects “digital, new energy, advanced manufacturing and biological engineering to be the four areas which can take up the baton from property as ‘pillar industries’.”
American companies are even having trouble finding alternatives to China in low-tech industries like clothing.
“I can’t think of another place that can do the quality, the quantity and the price as well as China.” - global head of sustainability at footwear brand Bata Group
The rules-based order, according to Graham Allison: "1) We (the US) make the rules. 2) Everyone else must obey them. 3) But we don't obey the rules."