Eastern Europe Has a Role to Play in US-China Economic Competition
As the 2024 US presidential election kicks into high gear, Democrats and Republicans are trying to make the case that their respective candidates represent different economic and geopolitical development models for the country. But this is not the case; there is no zero-sum contrast, nor is there an ideological one, and the candidates share a lot in common. One stark commonality is protectionism, and a shared unwillingness to open the domestic market to new partners amid a wave of ‘friend-shoring.’ Trump wants protectionism by custom tariffs, i.e., by isolationism. The Democrats have lurched toward trade negotiations with potential IPEF partners, a process that has ground to a halt precisely because US market access remains off the negotiating table.
The United States has the smallest volume of FDI in the dynamic region of ASEAN countries, coming in behind both the EU and China. The Democrats might excuse themselves here since they could not get a pro-trade agenda through a Senate rendered hostile by the choices of the voting public. But if that is the case, what are US voters missing when they assess the costs-benefits of the free trade-isolationism spectrum?
The unavoidable fact is that the United States cannot be a leader in manufacturing, investment, export capacity, or supply chain control so long as China enjoys a 10x advantage in manufacturing labor force output. It is a truism that manufacturing industries have faster productivity growth than service industries and may offer a more powerful GDP growth traction. But the US economy has not known these benefits for decades. The U.S. will perhaps never be able to mobilize the number of Chinese industrial workers. Therefore, it needs to improve its stagnating manufacturing productivity to compete successfully with the more labor resourceful yet non-democratic China.
The work of economist Joseph Politano breaks US productivity stagnation down by industry and reveals a broad trend that holds across American industries in general. To overcome this long-term problem, the US manufacturing economy must increase its capital intensity usage, for which it still cannot find reliable domestic drivers. It would be even less possible to find them within an isolated/protected domestic market. How then can Eastern Europe help in firing up the motor of capital intensity?
The Polish example: Which has grown faster, Poland or China?
It may seem like a silly question. Poland is great, but everyone knows China is the world’s growth champion… right? Just look at a comparison of how far each has come since 1990:
But the thing is, China’s hyper-growth started from a very, very low base — much lower than Poland’s. When we look at the actual number of dollars that each country added to its GDP over the past few decades, Poland actually comes out comfortably ahead. In fact, Poland has been slowly but steadily increasing the difference in GDP between itself and China:
Should we think about growth in exponential or linear terms? Usually, we define growth as a percentage rate — we think of it as exponential. But just because you can calculate the percentage growth rate of something does not mean that it has an exponential functional form. In fact, there is some evidence that as countries become rich, growth goes from exponential to linear.
Thus, to perform a real apples-to-apples comparison, we need to compare the countries’ growth rates at similar levels of income. One fundamental fact of development economics is that poor countries have much higher potential growth than rich ones. “Potential” does not mean “actual” — poor countries do not always grow fast, and many remain mired in poverty. But if you are a poor country, you can A) absorb a lot of foreign technology without having to invent it yourself, and B) save and invest a lot to increase your capital stock. That means it is easier to grow fast from a low base.
In 1991, Poland’s GDP per capita (PPP) was about the same as China’s in 2012 — somewhere around $10,500, so we can look at percentage growth rates in the years since hitting that level.
The growth rates over these years since $10,500 look roughly comparable (and keep in mind that China has probably overstated its growth since the pandemic, and possibly earlier as well). What is interesting is that in recent years, China’s percentage growth has steadily slowed down, while Poland’s has held constant or actually accelerated. In fact, if we project the trend lines since $10,500, Poland comes out looking a little better, due to its recent reacceleration and China’s recent deceleration.
Source: www.theglobaleconomy.com/economies/
The table above indicates that Poland has added $22,820 GDP per capita with PPP 2024 since 2012 while China managed to do so only with $12,190, regardless of their GDP percentage growth in the same period, i.e., Poland almost doubled its wealth per capita vs. the Chinese parallel indicator. To top it off, if we consider the table below, we shall see that Poland has done it as its average salary for the term, surpassing the Chinese one only by 33.82%:
Source: www.theglobaleconomy.com/economies/
Further, China marked an average annual growth in its manufacturing output for the period 01/2001 – 05/2024 of 10.35%, generating GDP of USD 5.61 per kg. oil equivalent used prior to 2015 (I was not able to find more updated data for that) with investment to GDP of about 43%. Poland reached average annual growth in its manufacturing output for the period 01/2001 – 05/2024 of 5.23%, but generated GDP of USD 10.77 per kg. oil equivalent with investment to GDP 22-24%. Therefore, Poland almost doubled its GDP per capita with PPP 2024 since 2012, making $22,820 whereas China registered $12,190 or only 53.42% of the Polish GDP per capita with PPP 2024 growth despite its twice higher average annual growth in manufacturing as percentage of GDP and twice higher investment for that purpose. This kind of data confirms that the Polish economy and its manufacturing sectors in particular possess superior capital intensity use than the Chinese ones. This truth cannot be obscured, even by the generous Chinese state subsidies to export manufacturing.
The same is true if we compare the Polish manufacturing data to the United States. The situation is analogous in the comparisons of other Eastern European manufacturing sectors with the Chinese, Vietnamese and the Malaysian (the Asian FDI champions). Singapore on the other hand is a very small and too costly destination for setting up new large manufacturing ventures. That is why Eastern Europe holds out the promise to the United States to reduce the cost of its industrial input, to increase the manufacture of machines for machine building, to outsource productions, and to augment industrial exports. All of these options are correlated features of a higher level of capital intensity in the manufacture, i.e., of improved labor productivity.
None of these objectives are achievable by isolationistic economic policies, where lower cost industrial inputs are absent. Besides, lower cost inputs are often protected on the spot by custom tariffs. The US government, owing to essential US investments in Eastern Europe, can lobby extra levies in that sense, if necessary. It would be a good counterpoint to Chinese state subsidies. Furthermore, the demographic capacity of this part of Europe does not add undue risk for raising unemployment rates in the U.S., even at the highest level of capital intensity use (reaching large exports) should the US domestic market be open to the import of goods from Eastern Europe, neither could these imports threaten US national security, which can’t always be said of similar investments in Asian countries. Finally, investments in Eastern Europe can pave the path toward internal access to the EU market for US businesses as well.
Examples of re-shoring practices in Eastern Europe
The most important application would be the construction of machine building plants. This would greatly facilitate US re-industrialization domestically and create the potential for sharp increase in US manufacturing exports while opening new jobs in America. Machine building would practically unlock the necessary augmented capital intensity for use in US manufacturing via low-cost manufacturing inputs from Eastern Europe.
A relevant example is outsourcing the production of batteries and elements for solar panels. The lithium deposits of Ukraine can be useful for batteries production after the war ends. The Biden administration has already seized about $5 billion of Russian Central Bank assets located on US territory, but instead of using them for Ukrainian benefit, it prefers to follow the mediocre line of G7 countries and do nothing meaningful with them. Alternatively, the confiscation and sale of the assets could allow the construction of huge plants (maybe in Poland) for the manufacture of at least some kinds of arms among battle tanks, aircrafts, ammunition, anti-aircraft systems, battle ships, drones and any other necessary weapons, with possible enormous impacts on the functional capacity of the Ukrainian army. In the post-war years, the plants will work for NATO in Europe, as most of its member states nowadays keep very thin stockpiles of almost all kinds of weaponry. The US administration could also reach an official agreement with the Ukrainian government in exchange for these plants construction to receive some favorable rights on exploiting the local lithium within a preliminary contracted period and volumes. This would enable the U.S. to structure an entirely new supply chain from lithium extraction to EVs manufacturing, completely independent of Chinese influence and globally competitive from a cost/benefits viewpoint.
The largest value added in the chain may be situated on American territory, e.g., the assembling and sales of the EVs. Ukraine will also be boosted in its war efforts with a massive inflow of manufactured weaponry and will have in the post-war days of economic recovery a ready business to bring in revenue. It is not difficult to imagine what can follow if the US government adds to this $5 billion another $5 billion, either as a subsidy or as a guaranteed state commitment on corporate investments. The result would be the appearance of two new industries – A European-based US battery venture and a Ukrainian defense venture.
The US government can also support the construction in Eastern Europe of several factories for the manufacture of legacy chips, helping to overcome the CHIPS Act gap of not supporting their production by government subsidies. Globally, about 70% of chips are mature ones and only 30% advanced ones. China has increased its share in the production of legacy chips and thus enhances its control over the corresponding global supply chains in this critical industry. Small countries in Eastern Europe, such as Latvia and Bulgaria, would certainly be happy to host US factories for mature chip production, even if this kind of product is less lucrative than advanced chips.
Looking forward, what can be done? The US government may introduce a Re-shoring and Re-industrialization Act (RSRIA) envisaging subsidies for re-shoring cost reimbursements in some manufacturing sectors and tax credits for new overseas investment projects in these sectors. RSRIA should be synchronized with the IRA and Chips Act where appropriate. Studying the Japanese re-shoring experience could be useful as well.
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