Recent events have demonstrated how dependent on China the United States has become for critical needs. The ongoing coronavirus pandemic has demonstrated the supply chain vulnerabilities that exist for antibiotics, personal protective equipment (PPE) and other medical equipment. This newly-appreciated vulnerability has occurred against the backdrop of the Trump administration’s efforts to eliminate Chinese electronic infrastructure companies from the U.S. supply chain for cybersecurity and broader national security reasons. And most recently, China’s adoption of its “Hong Kong Security Law”, and Congress’ reaction – the Hong Kong Autonomy Act, establishing a sanctions regime for Chinese persons found by the Departments of Treasury and State to be undermining the autonomy of Hong Kong – only adds to the complexity of supply chain decision making.
Join a distinguished panel of experts, Joanne Medero, Daniel Ahn, and Bryan Smith, as we delve into whether searching the U.S. supply chain for opportunities to remove Chinese participation is beneficial to U.S. national security, and whether it is even possible. What complications will arise if the U.S. does so? Have recent attempts to remove some Chinese electronics manufacturers been successful? How do China's new Hong Kong Security Law, and the U.S.'s Hong Kong Autonomy Act enacted in response, impact the relevant financial and trade landscapes? And what antitrust or other collateral issues will need to be considered if the United States moves further to remove Chinese participation in our supply chain?
Daniel Ahn, Managing Director, Chief US Economist and Head of Macro Strategy, BNP Paribas
Joanne Medero, formerly Managing Director, BlackRock, Inc.
Bryan Smith, Senior Fellow, George Mason University National Security Institute
Moderator: W. Hartmann Young, Senior Counsel - Government Business, GE Aviation
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Greg Walsh: Welcome to The Federalist Society's Teleforum conference call. This afternoon's topic is titled, “Supply Chain Security and Global Power Competition: Should the United States get China Out of its Supply Chain?” My name is Greg Walsh and I'm Assistant Director of Practice Groups at The Federalist Society.
As always, please note that all expressions of opinion are those of the experts on today's call.
Today, we are fortunate to have moderating Mr. Hartmann Young, a Senior Counsel of Government Business at GE Aviation. After our speakers give their opening remarks, we'll go to audience Q&A. Thank you all for sharing with us today. Hartmann, the floor is yours.
Hartmann Young: Thank you Greg and thank you everybody for joining. As Greg mentioned, my name is Hartmann Young. I'm Senior Counsel for Government Business at GE Aviation in Cincinnati, Ohio. I'm really pleased to be serving as your moderator for today's panel, “Supply Chain Security and Global Power Competition: Should the United States get China Out of its Supply Chain?”
I'm also really pleased to introduce our fabulous panel of speakers today. I'm sure that they are well known to many of you, already. First, we've got Daniel Ahn, Global Fellow at The Wilson Center and former Chief Economist at the State Department. Second, we've got Joanne Medero, a former Managing Director at BlackRock. And Bryan Smith, a Senior Fellow at the George Mason University National Security Institute.
I suspect my job as moderator will be a little bit easier than that of Susan Page or Chris Wallace. In any event, I sure hope so. I'll give you a few ground rules. There're not many. We'll turn to each of our panelists for about 10 minutes, and then we'll have a bit of back and forth, and then open up the line for questions.
By way of introduction, I'll mention that issues surrounding China and its presence in the U.S. supply chain, really multiple U.S. supply chains, have gotten a lot of attention in recent months. Issues go well beyond the defense sector. But within the defense sector, where I work, there have been a number of new rules and revised rules, designed to address the security of the U.S. supply chain. There has been, for some time, a prohibition on defense contractors acquiring certain items from communist Chinese military companies.
There's some relatively new guidance implementing Section 889 of the National Defense Authorization Act for fiscal year 2019. It does two things. First, it makes it clear that government contractors cannot provide products to the U.S. government that contains telecommunications equipment or video surveillance equipment from five companies, Huawei, ZTE Corporation, Hytera Communications Corporation, Hangzhou Hikvision Digital Technology Company, and Dahua Technology Company.
By the way, there are scores of other names of affiliates of those five companies, which makes it a real challenge. The most recent guidance on Section 889 makes it clear that, even apart from not providing this type of equipment to the U.S. government in a product, the companies that are contracting with the government can't even use that type of equipment for themselves, which makes it a further challenge. But you see how seriously the government takes the Defense supply chain and the U.S. Government Contracting supply chain, in general. Companies who run afoul of this rule run the risk of serious legal liability.
I'll note, also, that China is part of the reason for our nation's specialty metals regulations. And I'll note that the President, just over a week ago, issued another executive order regarding China and the fact that it provides the U.S. with 80 percent of its rare earth elements and called for a series of studies to be done into that issue. But China also serves as a big part of the backdrop behind the Department of Defense's latest regulations regarding cybersecurity. So China, supply chain implication it causes, and how our government addresses those issues, has become a large part of my practice. That's just my industry, aerospace.
There are a lot of other aspects to the issue, as we've seen with COVID-19's impact on PPE, medical equipment, antibiotics, and other industries. There are trade impacts, economic impacts, national security impacts, other legal things that we need to consider.
So I'm going to turn it over to our expert panel, now, and we'll start with Bryan, and then turn it over to Daniel, and then Joanne. Bryan, you have the floor.
Bryan Smith: Thank you, Hartmann. I'm going to briefly talk about some historical background, move into the unique policy challenge that supply chain management represents, talk about the response framework, and then deal with three of the questions that were posed on the web posting for the panel.
So for three decades, the West has labored under the theory that China's integration into the global economy would unleash forces that would transform it into a democracy, a play by U.S. established rule-based order and be a solid, responsible, global citizen. Well, that has not worked out. That theory has been proven wrong and there's a consensus that we can no longer operate under that.
In some ways, the U.S. and the West have been transformed more by China than we have transformed it. Given our dependency on China, and many strategic areas, and also for just commercial success, we've grown too tall, or too long, of China's IP theft, its mercantilism, malfeasance, including the way that we've looked the other way at multiple human rights, malpractices. Also, China's mercantilism has seemed to have rubbed off on us in significant ways.
Prior to COVID, the U.S. had awoken to the impact on national security of the Chinese -- China's aggressive behavior and our own supply chain vulnerability to China. There was a groundbreaking study done by Mitre the Defense Department called Deliver and Compromise, in which they laid out the vulnerabilities for national security of certain supply chain elements and suggested that, in addition to cost, performance, and schedule, there would be a fourth pilar for national security products, and that would be reliable trustworthy supply.
Some companies have already shifted some of their supply chains away from China, given concerns about vulnerabilities relating to the U.S./China relationship, and also because of the rising labor costs for some Chinese products. So COVID, then, put these preexisting trends into hyperdrive, really, two catalysts. Realization of the extent and effect of dependencies in the medical area and China's buying up and hoarding the global medical stocks.
The supply chain issue area is a really tough challenge for U.S. policymakers. And I think there are four important dynamics that combine to make this issue extremely challenging and that tightly entangle security and commercial elements. First, national security concepts have become much broader in scope over the last decade or so, moving from strictly military intelligence domains to securing national critical infrastructure, and maintaining the technology base that supports all that. Second, the technology base for national security has, likewise, become broader. And the technologies that are driving the commercial potential for what's known as the fourth industrial revolution are the very same technologies that are critical for maintaining national security. Third, the cutting edge of this technology base is found in, now, in commercial industry rather than, for the most part, in the traditional defense industrial base. And fourth, and finally, the U.S. edge in this fourth industrial revolution technologies has greatly eroded and is shifting to China.
Well, the upshot of these dynamics for potential decoupling from China is the policy options necessarily involve key commercial technology companies in extraordinary, complex, messy, and often unpredictable ways.
The response framework, what are we doing? I think of this in -- I kind of put it in two -- according to two broad techniques. One is simply called negative, which is to isolate and/or punish the supplier of concern. And the second term, positive, which is to develop and promote more resilient alternative sources. And that's not to say that negative is bad. There are negative policy options that are very good and we should be doing. But it's just the two terms that I've used. They're not normative.
And then there are two spheres involved. One for nation states. What do they do to protect their national security and critical infrastructures interests? And then what do companies need to do to ensure resiliency and reduce their risk from the fallout of nation states conflict?
So there are three panel questions I'll address. The first is, is it beneficial to remove China from key supply chains. Here, I'd give a qualified yes. The benefit depends exactly on how dependent we are and are likely to be for a particular product, service, or industry. And second, how that dependency translates into vulnerability. And one of the best insights I've seen into those questions was provided by a study done by the Henry Jackson Society, posed to researchers and politicians from the five eye countries. And their construct was, first they created the concept of strategic dependencies. So to operationalize that country to be dependent, the area had to involve net import of -- the country had to be a net importer of the product. Fifty percent of those imports were from China, and China controlled thirty percent of the global market.
And not surprisingly, the U.S. had some important strategic dependencies in those areas. They identified 2 of 11 infrastructure industries where we had dependencies. 29 sectors in 114 specific categories. These included rarer metals, which are, of course, along with other industrial metals, captured in that E.O. that Hartmann referred to. Vitamins, certain high-tech products, including laptops, microphones, lithium ion batteries. And in the ranking the five eye countries, the U.K. was least dependent on China, Australia the most, and U.S. kind of in the middle with New Zealand and Canada.
Second question is, can China be removed from select supply chains? Is it really even practically possible? Well, I would say yes, and in fact, it's underway. Especially in the digital domain. And by the way, this is a two-way street. China, earlier, removed -- speculatively removed many U.S. digital offerings from its own supply chain, due to the way it operates its internet. And it certainly is determined to become independent from the U.S. semi-conductors supply chain.
So almost anything can be done, I believe, if it's sufficiently important and enough resources are poured into it. After all, when you think about what it took to establish these supply chains in China, it was a decade long effort, or more, involved massive resources, investments, from both China and the West. So who is to say that this feat can't be achieved in Indonesia, India, or Indiana? So while it's certainly possible and there's movement that way, it, nonetheless, is a fact of life that, currently, China remains unmatched as a manufacturing site for many industries.
Now, in the digital domain, both due to policy and the way technology is evolved, and due to both U.S. and Chinese actions, we're seeing the world's digital plumbing split into two separate, what I call, parallel universes. There's a U.S. offered ecosystem with the free -- internet free from sponsors, from censorship, with certain dominant U.S. apps in search, shopping, and social media. And a similar ecosystem with China, the heavily censored internet with integrated suite of Chinese apps. Now, Huawei attempted to cross this digital parallel universe and be the backbone for both of them. And as a result, has reaped the whirlwind, and I hope we'll have more time to talk about Huawei.
Third question, are current efforts working? Well, here, I'm reminded of an exchange between Henry Kissinger and Mao Zedong, where Kissinger asked Mao, was the Chinese revolution -- was the French Revolution a success? And Mao replied, well, it's too early to tell. So I think in some of these areas, it is too early to tell.
One area where I think it's -- I would give a qualified, yes it's working, is in the goal of limiting Chinese ownership and influence in U.S. companies where national security interests are involved. So with the firma improvements that Congress made, we've seen the decline in Chinese foreign direct investment in the U.S. from 47 billion in 2016 to only 4.8 billion in '19. An area where it's too early to tell is the sharp kind of aggressive negative decoupling that we've made with Huawei and with TikTok. I think there's -- you could point to some real wins in the near term, but there are potential major costs down the road, especially to certain suppliers, U.S. suppliers. And it really will depend in part on the Chinese future response.
In the area that I call positive decoupling, trying to find alternative sources, alternative reliable sources, I point to what I call three starts. First there was a false start, which was talk in the U.S. about the government taking an equity position in the friendly semi-conductor supplier. Second a promising start with the U.S. TSMC deal to build a semi-conductor plant in the U.S. TSMC is Taiwan Semi-Conductor Manufacture Corporation. And then what might be a start and stop. And that's the clean net initiative from the State Department. It's getting some traction now, diplomatically, but unless it pretty soon transfers over to Commerce Department to be operational and becomes something really substantial, it may die a premature death.
So with that, I'll turn it back over to you, Hartmann.
Hartmann Young: Thanks so much, Bryan. Daniel, you are next. You have the floor.
Daniel Ahn: Thank you Hartmann. It's going to be tough act to follow Bryan's excellent set of first remarks. So I'm going to mainly restrict my comments to two small points and then one kind of bigger point, with the first two kind of building again upon Bryan's introductory comments.
So when we talk about supply chain and decoupling and vulnerability, I think it is important to first distinguish between the short-term national security vulnerabilities that come from your dependence or reliance upon foreign suppliers, particularly suppliers that are embedded inside a potential adversary in times of crisis. And this can mean both military crisis, but as with COVID and PPE demonstrates, it can also be pandemics or other crises.
But in these -- when looking at these short-term vulnerabilities, I feel a lot of studies have been looking at metrics like raw dependents, share of imports, all of this stuff. And that's an excellent first start. And as an economist, I definitely value a data driven approach to this. But also, as an economist, I do want to warn people that just simple raw dependence does not necessarily translate into vulnerability. We have to consider, not just how much we're dependent upon a particular supplier, but also we must think about how easy it is to find a different supplier, how substitutable the input is, or how replaceable or even easy it is to simply do without that part. It's a concept that economists, in their wonky way, call the elasticity of substitution. And that, however, is something I think is much harder to estimate. But I think we need to think about these concepts and not just rely upon, again, dependence numbers as the end-all in thinking about where the true vulnerabilities in our supply chains lie in the short-term.
The second point I wanted to make is related to this, but it moves beyond short-term vulnerabilities and it's a more longer-term national security implications. On this sort of moves the discussion -- blends between decoupling and supply chains and into broader industrial policy questions. And here, again, I guess I just have a warning from an economist perspective, that we should all try to avoid the temptation toward technological determinism or fatalism. When I review a lot of the comments made by policymakers and politicians, citing the importance of critical sectors, like artificial intelligence, or quantum computing, or nano technology, or renewable energy, or hypersonic missiles, or whatever, these are all obviously important technologies. And they're already valuable or show promise in delivering a commercial or military edge.
In more of the long-term, it's impossible to know exactly in advance which technologies will be critical when it comes to the actual crisis point. And we can look back to history for a literal graveyard of all technologies that were tooted as the be all, end all of the time only to be left in the ash heap of history. I would note, for example, that in the runup to World War II, there was continuous struggles over the importance of how important, say, the battleship, the classic big gun battleship was going to be. And many of the major powers had poured considerable sums into this only to discover that with the advancement of things like the aircraft carrier and radar and all this stuff, that they moved more into adjunct status. Similarly, during the cold war, again there's been -- you can count all these technologies. For example, the civilian supersonic transport race, where again, massive sums were devoted into this that proved to be, at least, commercial dead ends, at least at the time.
So as tempting as it is to sort of point to A.I. or all this stuff as being critical next technologies, and certainly, I do think we should take these and monitor these technologies seriously, again, the longer term, I think the best way to ensure proper technological and secure independence and ascendency in a future conflict or a crisis of any sort is really to go back to the basics and ensure an effective, and rules-based, and fair, and competitive economic marketplace that properly worked innovation rather than market power that attracts high quality human capital from all corners of the world. And indeed, provide incentives to internalize the "externality" of national security needs. So that's the kind of another second cautionary point that I wanted to make.
The third point I wanted to make was to discuss another, I guess, shadow of supply chains that is also decoupling. Bryan already discussed, on top of the regular physical supply chains of the digital ecosystems. I wanted to discuss a bit on the financial service kind of ecosystems and the critical role that it plays in underpinning both the physical supply chain, but also its role in national security statecraft.
So basically, currently, the Western, or the U.S., and in Europe and Western European ecosystem of financial service providers is generally seen to have a number of technological and critical quality advantages. We can look at the ubiquity of the U.S. dollar as both the reserve currency and as a transactional currency. And despite all the doom-sayers, it has entrenched and increased its status in the recent decades. We can look at the depths and liquidity of dollar-based capital markets with deep pools of expertise in financial services. And it's been interesting, I think as I'm sure many of you know, the story of the last two decades or so has been one of where the U.S. government has been exploiting the centrality of the U.S. and Western financial infrastructure as the unsung plumbing to provide things like trade financing, and a flow of credit, and maritime insurance, and so on, to impose economic warfare. To using targeted economic and financial sanctions in pursuit of noneconomic objectives.
But here, we are starting to see the ecosystems grow apart, even as Western banks have tried to build branches in the U.S., and have made arguably halting progress in developing branches there. The Chinese financial ecosystem, which has been dominated by large state-owned banks, have actually been advancing ahead in key areas, most notably in digital payments through things like Alipay, which is not a large state-owned bank, but both the example of Alipay, and also I would argue recently HSBC, shows how much the commercial financial sector in China and in Hong Kong, as well, is being coopted or pressured by the communist regime to affirm their loyalty of and bring in their in-house talent and resources.
I also note, as I think many people have, that the overusage of a lot of these economic warfare tools, especially extraterritorial secondary sanctions imposed in a unilateral, rather than multilateral fashion, can only incentivize and hasten the creation of alternative ecosystems that compete with U.S. and Western capital markets and bypass U.S. jurisdictional reach. Already, China, Russia, North Korea, Iran, and others are clearly seeking technological ways, such as through bitcoin and other anonymous cryptocurrencies that attempt to disrupt and bypass the U.S. and dollar-based financial system, entirely. They haven't been terribly successful at this, other than kind of at the fringes of the black-engine grey economy, but it does show that we shouldn't take the centrality of the U.S. financial system for granted.
And then finally, I kind of want to mention, much like I was discussing in the material supply chain commentary above, that I really think that policymakers could use more proper data-based decision making and analysis around this. And in a kind of shameless plug, I will mention some of my own research that I actually started while I was at the State Department, looking at not country level data, but actually micro-corporate individual level big data. We're talking about millions, or even billions, of datapoints to try and understand the impact of targeted or micro-sanctions. And I'm happy to go into more detail, if there's questions and answers in the Q&A session. But we find some really interesting and potentially counterintuitive impacts from this.
But yes, just to wrap up, we should also recognize that, again, the financial services, infrastructure, plays a critical, although often unsung, adjunct role to the physical supply chain and the U.S. government and others have increasingly been waking up to the power and the usefulness of this centrality in service of national security objectives. But we should also be cognizant of the long-term risks and dangers. And be strategic around the usage of these tools. With this, I will turn it over to Joanne.
Joanne Medero: Great, thank you. So as the lawyer on the panel, I thought perhaps I should also create a bit -- some background. One of the driving events, besides COVID, this year was the passage in China, or in Hong Kong technically, of the Hong Kong Security Act. This became effective June 30. And it is a -- well depending on how you look at it, but from most Westerners, they would say that it undermines the agreements related to Hong Kong and its autonomy going forward. It is a very broad statute that is intended to increase the control of China over Hong Kong under a guise of stability and national security.
The thing that I think is most worrisome to Westerners who are doing business in Hong Kong, or in China through Hong Kong, is that its reach -- it purports to reach, not only residents or permanent residents of Hong Kong, but also nonpermanent residents and individuals and entities, and broad-sweeping powers. Everything that I would say, opposite of the U.S. Constitution, in terms of its reach and its power. That has given, I think, a number of companies doing business in Hong Kong, or in China through Hong Kong, pause and concerns about their employees in Hong Kong, or their national -- those employees who may be ethnically Chinese and whether they would want to travel to Hong Kong.
So every action has a reaction. And in response, and I think this was burbling along anyway, we had an executive order from the President in July. What it did is, it declared a national emergency with respect to the situation in Hong Kong and imposed sanctions, which Daniel just talked about, in terms of actors engaged in these activities. So it goes to individuals and to entities. And uses, basically, the fact that we are -- the global economy is very, still, dollar-based as a way to limit the interactions that U.S. companies can have with these sanctioned individuals and entities.
Congress also enacted similar sanctions, as well, and then what's also developing, and again accelerated by COVID, and also the Hong Kong Security Act, is a broader idea related to decoupling of the economy. And that is to limit the access of Chinese companies to the U.S. capital markets. This is -- would be kind of unique. It started, actually, originally as concerns raised by the SCC as to the accounting practices of Chinese companies that are listed on U.S. exchanges. But has gotten much broader and much more brought into the debate about the decoupling of the two economies. So there is pending, in Congress, two bills. One in the Senate, one in the House, that would force the delisting of Chinese companies from U.S. exchanges.
There's also been, I would call it, political pressure put on the Federal Pension System to not broaden their international index that is offered as an investment option to include merging markets that has a significant percentage in China. The idea here is, the U.S. doesn't engage in direct capital controls. But the idea is to not fund or fuel the Chinese economy through U.S. capital.
Now, if you're a retail investor and these companies were, in fact, delisted, you may not be able to purchase securities of these companies. But if you are an institutional investor and you're large, you're going to find a way, if you want, absent a specific sanction. But you would acquire shares in these companies in other means. So I think one has to be careful that when you -- just as was mentioned about digital currencies as a substitute for the U.S. dollar, I think you have to be careful that you don't empower other regions, in terms of their capital markets. And some say that, in fact, the Chinese government welcomes delisting because it would force these Chinese companies to have their primary listings in Hong Kong or Shanghai to the benefit of the Chinese economy.
So there are two sides to all of these things. Now, the interesting thing about this legislation and some of the other proposals is that they've been bipartisan. So the -- everybody's a China hawk, at least until the day after the election, right now. So that's another thing to keep in mind.
Now, the last thing I'm going to mention, and perhaps we can talk about it a little bit among the panelists is, we've all been talking about how to remove your supply chain from China and that decoupling. But the urge, I'll call it, or the perspective of a lot of U.S. companies is, here's this vast market that we want to be able to sell into. And there's consequences to that and expectations in an economy that is so government controlled about what you -- how critical can you be of the government, how can you do business and sell into that country, and not have limitations or whatever, in terms of your exports. So it's a challenge, I think, that Western companies are really grappling with, at this point.
So Hartmann, I'll turn back to you for questions.
Hartmann Young: Great. Thank you so much, Joanne, and the rest of the panelists. I'm really fascinated by this idea about parallel ecosystems. I'm not the economist on the panel. I'm not going to pretend to be one. But there are estimates that are publicly available that China will overtake the sight of the U.S. economy sometime in the not-to-distant-future and I think, along with that, will come this leverage that China already has, to a large degree, that will have to an increasing degree to attract more participants to its ecosystem.
I think, Daniel, you raised some interesting aspects, how China could leverage that into the financial sphere, as well. But I want to bring back something that, Bryan, you had mentioned about Huawei. That's a good case study, I think. There's tragically, every day, stories about what we're going to do with Huawei. Are allied governments going to keep Huawei in their networks? Are they going to remove them from their military networks? There was something in the paper, just today, related to Germany and its relationship to Huawei. What do you think the options are? And what do you think the likely future is for Huawei?
Bryan Smith: Thank you Hartmann. So the U.S. government has taken a number of escalating steps. And its policy goals, with respect to Huawei, it's hard to tell exactly what they are. Are we trying to choke Huawei, or kill it off?
So one step you mentioned, the National Defense Authorization Act Section 889, that was to keep Huawei out of our market. Similarly, there's an FCC ruling that designates China as a threat to our telecom systems, and therefore it prevents Huawei from gaining funding through the Universal Service Fund. I think I've got that term right. That is a kind of a support for real networks. And then under IEEPA, the Administration listed Huawei on its entities list and, essentially, meant that our companies cannot supply Huawei.
Then there was a killer move in August of this year to close a loophole where China was buying equipment from, especially chipset, from companies that were not U.S. but had U.S. content in it. So right now, Huawei is on the ropes absent a totally domestic -- Chinese domestic high end chipset provider. There revenues have gone down in '19. They'll go down further in '20 and they'll really be hit hard in '21.
So I kind of see probably four scenarios. One is the U.S. strings Huawei along but keeps it kind of at bay. So it grants a license a company, say Taiwan Firm Media Tech, which can supply workable chips to Huawei, but keep them from being on the growth path they were before. I could also see Xi going to Trump or Biden with a power play, where he threatens serious retaliations against companies like Qualcomm, Apple, GM, Starbucks, you name them. And then a deal is worked out quietly to let Huawei off the ropes.
The least likely scenario, but it's still a scenario is that Huawei simply goes bust. I mean, they've got enough cash probably, people think, for a couple of years, but of course they could be supported. But under that scenario, where they go bust, Huawei spins off their chip design arm and gets cash with that and then becomes a different kind of a company.
Finally, and I think this may be the most likely, is that no matter what the U.S. does, the communist party keeps Huawei on indefinite life support until China develops a world-class chip manufacturing capability of its own. So I think, given how high profile this issue has become, it is way too important for the Chinese communist party to let this national champion go down in flames. You know, you've got 1.4 billion consumers who are going to buy Huawei phones, even if they're not quite -- even if they don't provide Google apps or some other features. So it's tough to say just where, exactly, that's going, but that's my -- that's how I would view the landscape.
Hartmann Young: I would be inclined to agree with that latter option, with the Chinese Communist Party keeping Huawei on indefinite life support. It's an important company. I don't know what the prospect is in the medium-term, or near-term, for them to get a chip development capability that's on par with the U.S. companies. But certainly something to keep an eye on.
One of the rules that I mentioned early on for defense purposes is a prohibition against procuring items from, what we call, communist Chinese military companies, that's a DoD rule. The breadth of the influence of the communist Chinese party is something that I've often wondered about because of the way it's defined in this regulation, is that you can't buy certain items from what's called a communist Chinese military company, which could be anywhere in the world, regardless of geographic location, as part of the commercial or defense industrial base of the People's Republic of China, including a affiliate of it, or is owned or controlled by or affiliated with an element of the government or armed forces of the People's Republic of China.
So you look at a definition like that and you're sort of wondering, is there ever a company within China that's immune from government interference? Somewhat luckily for defense contractors, there's only a finite list of items that are subject to this prohibition. They have to be on the 600 series of the commerce control list. Or they have to be otherwise on the U.S. munitions list as a defense article. But it sort of raises the question, is there any type of company that is beyond the reach of the communist Chinese party?
I'd like to ask a little bit more about something Daniel raised, this idea of the financial system in the U.S. as being sort of the unsung hero. Daniel, and Joanne, you might want to comment on this as well, are there additional things that the U.S. ought to be doing to ensure the continued longevity of the primacy of sort of the U.S. based financial system?
Daniel Ahn: Yeah. Thanks Hartmann for that question. It's a big broad ranging one, so I'm sure we can spend all day discussing it. But indeed, I do think it is, in many way, the unsung hero. Just as a little tidbit, we found that for any industrial sector that is one percent more dependent upon Western financial service inputs into the value function of its production, that causes a seven-fold increase in the impact of the sanctions hit, if the target in that business sector does get sanctioned.
So yeah, this clearly is a critical transmission mechanism by which sanctions hurt. Therefore it is an essential, I think, and a useful national security tool that should be used with both care and strategic thought. In terms of how to reinforce it, I mean, we can go through a list, a litany of all the things that economists like to say. Threaten the primacy of the U.S. dollar. But again, I think a lot of it, it goes back to basics around ensuring a stable, balanced, healthy, growing economy.
I do think, however, that there's a lot of questions around cryptocurrency and then broader kind of digital disruption of the financial sector, especially in these very unusual times, not just because of COVID. But recall that even before COVID, international economists were grappling with a lot of major structural problems, such as declining national rate of interest, Japanification seemingly spreading into Europe and then possibly to the U.S., a serious fall in the pace of technological productivity growth. And so there are questions, again, about whether we can still rely upon the old system, or moving to a new system in a world of -- at least for the foreseeable future, if you believe perpetually low nominal interest rates.
So, I mean, I don't have all the answers on this, but I do feel that the U.S. government should stay abreast, and the Federal Reserve, and Treasury, and the IMF, and BIS, and so forth. They should all be watching financial technology developments carefully. I think cryptocurrencies, with the emergence of successful anonymous cryptocurrencies, the genie is out of the box -- or the bottle. And that instead of just hoping that that'll go away, or dismissing it as something that just operates at the fringes of society, that a government should take a leading role, if not a direct role, a critical indirect role ensuring that there is a successful commercial development of products that properly blend the advantages of a frictionless digital transactions. And maybe that's block chain based. Maybe that's something else, I don't know. But something that takes advantage of continued technological progress in the digital space without jeopardizing a lot of the hard won advantages that comes from this dollar-based Western ecosystem.
Hartmann Young: Great, thank you. Joanne, I don't know if you want to comment on that, but I have an additional question for you, based on your comment that as we are headed into an election in just a few weeks, you are finding a lot of China hawks. But there are other elements within our economy that definitely want access to the Chinese market. I know we talked about the National Basketball Association and some other industries where access to the Chinese market, it seems, is critical, that might affect behavior. It might affect the whole calculous about removing China from our supply chain.
I'll mention, also that in aerospace and defense, where I practice, the government's power, indeed the President's power is at its zenith when it comes to imposing restrictions. There's no real doubt that the federal government can impose the restrictions that it does for national security reason. But other supply chains, whether they be related to PPE, antibiotics, other medical equipment, other cyber related but commercial equipment, it's not so easy to make that judgment that the government can, in fact, remove China from the supply chain without there being some ramifications, whether through international trade courts or through some other means, or based on U.S. law. So can you tell us about some of the downside of taking some of these measures, with respect to China? What types of legal issues are likely to arise? What are types of things ought we be aware of if we move further down this path? And again, not in the defense industry, but perhaps some of the other industries we talked about.
Joanne Medero: Right. Well, any country, right, when you need a license to do business, and obviously regulated industries would be things like pharma, financial services, in some cases telecom, things like that, airline, it's always a challenge, even without a government controlled economy, which is what China is, to do business there. And I think even the heightened tensions between China and the West right now, it's even more difficult. And companies that want to do business in China and require government approval to do so have probably gone to ground, somewhat, rather than be seen as part of the critical chorus.
But you know, you have to think about too your ability to emigrate or immigrate, work visas, things like this that you have, frankly, all over the world. You don't need to be dealing with a communist country to deal with that. It's just that the power seems to be greater right now, given the tension. Not sure I actually answered your question.
Hartmann Young: No, I think you did. And let me ask, at this point, Greg, if you want to open up the line for audience questions?
Greg Walsh: Sure. We'll now go to the first caller.
Caller 1: I continue to see articles in the newspaper drawing distinctions, or supposed distinctions, between Chinese government entities and supposed private entities. But to what extent would you consider that a misnomer or an imposition of the American model falsely (inaudible 00:53:52). I mean, to the extent it's a communist controlled economy. It's my understanding the government (inaudible 00:54:59) in every entity there. And so when American businesses are doing business with a supposed private entity in China, it's not really a private entity. It's a government entity of China.
Hartmann Young: Who wants to answer that question?
Daniel Ahn: This is Daniel. I can take a first stab at it. So I think you have touched upon something critical, which is that we shouldn't necessarily project what the American model or the Western model in framework when it comes to looking at the Chinese political economy. In fact, I think there's a kind of eerie parallel between this, and also the realm of hybrid warfare. But putting that aside, yeah, this is actually a big struggle that we had faced, I'm thinking back to both, some of the negotiations around TPP, and then also the Section 301 investigations against China.
It's not clear where the state's role begins and ends when it comes to an authoritarian, a state capitalist state -- place -- economy like China. I do think that there are [inaudible 00:55:17]. There are clearly places that are fully state owned and are almost essentially directed from Zhongnanhai. But those are, I'd say, generally few and mostly sitting in the military or the defense establishment. Then you kind of get those national champion types that do ultimately report to the central government. But then we should remember that China is not a monolithic entity, either. And they have their own internal factions, and they have their own different objectives and micro-adjustments, although the communist party tries to all make them row in, more or less, the same direction. And then you've got a lot of state and municipal and provincial level -- state level governments.
And then you have private sector governments that are still reliant upon cheap credit or are accessed, or things like that. Still, I would say, a very vibrant and largely independent private sector, but which has seen both its relative operational freedom and independence erode under Xi's rule as he has attempted to instill a harder, more disciplined party line. And Joanne talked about some of this. And also just a decreasing share of the overall economic output as more of the resources have been devoted, again, to building up the state-owned, or at least state influenced parts of the economy.
Hartmann Young: Great, thank you Daniel. Greg, is there another question?
Greg Walsh: We have two more callers in the queue.
Caller 2: I have some question, but I just have to push back a little bit on the idea of the United States financial industry being this unsung hero. Basically, you have to look at it with respect to all of the deficits, the trade deficits that we have had with China, and then add those up year over year since the ‘80's and there's probably more Chinese dollars than there are within the United States. And so one has to wonder about the strength of the Chinese financial industry. I'll leave it at that.
Hartmann Young: Someone wants to comment on that, they certainly can. We have just a few minutes left, if that. So Greg, is there another question in the queue?
Greg Walsh: Yeah, let's go to the next caller.
Caller 3: My question is somewhat similar to the last one, which is how much of a threat is Chinese cryptocurrency to the U.S. dollar, as the world's reserve currency in the long term?
Daniel Ahn: Okay. Hartmann, should I try and answer --
Hartmann Young: Go ahead. Yeah, sure.
Daniel Ahn: On the first question, these are very complex issues, so I don't think anyone can be quite -- very reductive about these things. I don't want to give the impression that somehow I'm saying that Wall Street banks, or something, have been heroic national security warriors or anything like that. They're clearly entities that are pursuing their own commercial interests, as well. That said, what I think is more the unsung, or at least under appreciated aspects of one of our national security's strengths is the financial plumbing system of which the U.S. dollar sits at its core. So I wouldn't necessarily call it the financial industry, but they are in some ways the builders and the operators inside this infrastructure that has many sort of constituent parts.
The second part of your question, however, was around trade deficits and current account deficits. And there, I definitely want to push back against an idea that I think has, unfortunately, become very popular, but I think highly, highly misleading, that trade deficits, particularly bilateral trade deficits, are somehow -- are some useful metric for vulnerability, or something like that. Simply put, in this extremely hyper integrated supply chain system, what happens is that when you have an imbalance between the savings of a country and the consumption of a country, then you get this -- you get by almost accounting mechanically, current account deficits. Now whether that happens to be localized in China often depends on where exactly China sits in the supply chain. If China is the end supplier and end assembler of goods, like say you're iPhone, or something like that, then it often is listed in customs as being an export from China to United States, even if 90 percent of the value of the iPhone was actually assembled in the U.S., or Japan, or Taiwan, or South Korea, or whatever, as an export to China.
So yeah, the fact of the matter is, is that trade accounting statistics are very 1960s in a 21st century world. I do think that, overall, current account deficits, rather than bilateral trade deficits does reflect something more worrisome and it definitely is clear that the United States has been having these twin overall current account deficits, as well as federal deficits. And that, again, reflects the fact that we are consuming and not saving enough, relative to what we spend. So if we have a massive contraction in our consumption, then -- as often happens during recessions, then we also see our current account deficits go down. But we need to find a way to more structurally ensure that we are actually living within our means and consuming -- and saving sufficient shares of our income so that we can fund all of the investments that we also do without relying upon the borrowing on the international capital markets that is being funded by outsiders, including China.
On the second question, on the risk of a Chinese cryptocurrency, all I can say is we don't know what will happen in the future, but at present, efforts to make a digital renminbi, or a digital ruble, or used bitcoin and all that stuff, have largely been operating on the fringes of the global economy, rather than its core. Places attempts by China and Russia to try and bypass the U.S. financial system, particularly in things like trade with North -- with Iran and so on, have met difficulties given, again, the ubiquity and almost monopoly status that Western financial services, ecosystem provides in certain key services. But that isn't to say that things can't change in the future. I know for a fact that China is working very hard to try and create a separate ecosystem. And I feel that they are catching up hard, when it comes to the quality gap.
But also, there's a debate among economists as to the network effects around all of this. Some people argue that there's a powerful network effect. And once people start using the U.S. dollar, everyone starts using the U.S. dollar and it's really hard to wean off of the U.S. dollar, even if it's not necessarily the best theoretically available, like using the QWERTY keyboard, which has sort of snowballed from there. Others, however, say that the network effect is much weaker and we can see viable alternative ecosystems emerge, completely independent and separate from the U.S. dollar based system that will be perfectly fine substitutes until they can be merged as challengers. The debate goes on. I'm not going to take a position on that. But I guess, speaking more from a national security perspective, I suppose we can hope for the best, but we should plan for the worst.
Hartmann Young: Great. This is Hartmann. I see we are at our time allotted for this. But I do want to thank our panelists for appearing today to talk about a very fascinating and, in some ways, troubling topic. I want to thank you, Daniel, you Joanne, and you, Bryan for appearing today. And thanks so much for your help, Greg, and The Federalist Society in setting this up.
Greg Walsh: Great, thank you. On behalf of The Federalist Society, I want to thank our speakers for the benefit of their valuable time and expertise today. We welcome listener feedback by email at firstname.lastname@example.org. Thank you all for joining us. We are adjourned.
Dean Reuter: Thank you for listening to this episode of Teleforum, a podcast of The Federalist Society’s practice groups. For more information about The Federalist Society, the practice groups, and to become a Federalist Society member, please visit our website at fedsoc.org.