A Medium- to Long-Term Outlook for the US Economy
―Can America Win the Competition with China?―

Tatsuhiko Yoshizaki

1. What is Happening to the US Economy?

As of summer 2023, the outlook for the US economy is generally bright. Yet, if we pause to think for a moment, this is rather curious. The FRB has raised interest rates by 5.25% in just over a year; it would be no wonder if the US economy has sunk into a recession quagmire. However, FRB Chairman Jay Powell is confident in achieving his "soft landing" scenario of successfully controlling inflation without inviting a serious recession.

Recent economic indicators present a lineup of favorable figures. (1) Growth rate: GDP for April-June 2023 grew at a rate of 2.4% year-on-year basis. 2) Prices: US June consumer prices fell sharply by 3.0% year-on-year basis. (3) Employment: The June 2023 unemployment rate was 3.5%, close to full employment. President Joe Biden is boasting about the achievements of his economic policy, "Bidenomics," with an eye on next year's presidential election. 1

It is important to remember, however, that the US economy has undergone the following major changes over the past few years:

1) The COVID-19 pandemic raged from the spring of 2020. The death toll across the United States reached well over one million. 2

2) In the spring of 2021, the inflation rate reached the largest scale in 40 years. The FRB initially misjudged the price hikes as transitory and eventually tightened its monetary policy as late as the fall of the same year.

3) The FRB began raising interest rates in the spring of 2022, tightening its monetary policy at a faster-than-normal pace, including three consecutive 0.75 percentage point hikes. Furthermore, following the outbreak of the Ukraine war, rising international commodity prices of, among other things, energy and food has accelerated inflation.

4) In the spring of 2023, medium-sized regional banks, including Silicon Valley Bank, Signature Bank, and First Republic Bank, went bankrupt in succession.

Vicissitudes the US economy has undergone are such that nobody could predict with confidence what it will look like next spring. The post-pandemic global economy will look quite different from the past, but the entire picture is not yet visible. The prospect of the Ukraine war is anything but optimistic, and uncertainties are growing over the New US-China Cold War and the Taiwan contingency. The prolonged reversal of long and short-term interest rates may also pose difficulties for banks, which make their money by "borrowing in the short-term and lending in the long-term."

Hard as it is to foresee the future, this article is intended to discuss the medium- to long-term configuration of the US economy. Can the US economy continue to lead the world? In short, can it win the competition with China in a "New Cold War"? Although these are questions hard to easily answer, I want to offer my views on them.

2. US Advantages over the Medium- to Long-Term

When considering the medium- to long-term prospects of the global economy, few countries have such favorable fundamental conditions as does the United States. These include:

1) Population: The number of births in the United States in 2022 was 3,661,220, resulting in a synthetic fertility rate of 1.67 children per woman. 3 This figure is below the pre-corona level, failing to reach the value of 2.1 required to sustain the population, but it is one of the highest figures among developed countries. The US population, as a whole, grows due to the continued influx of immigrants. Net immigration in 2022 will reach 1.01 million, up from 380,000 the previous year, hitting a record high since 2017.

2) Industrial structure: The top five American corporations in terms of market capitalization are currently technology-based IT companies: Apple, Microsoft, Alphabet-Google, Amazon, and NVIDIA. 4 Meanwhile, the top five American companies as of 2000 were GE, Exxon, Pfizer, Citigroup, and Cisco. In just 20 years, the roster has completely changed. The greatest strength of the US economy lies in its system that accelerates innovation by attracting human resources, goods, and money to growth sectors.

3) Regional industrial strength: The US economy is strong in many sectors—not only in IT (mainly the West Coast) but also in a wide array of other industries, including energy and mining (American South), finance and services (American East), automotive (American Midwest), agriculture (nation-wide), and tourism (Florida and Hawaii). Each region has its leading industry, complementing each other; this is another strength of the US economy.

4) Energy self-sufficiency: It used to be considered the Achilles' heel of the US economy that America "must import large quantities of oil." During the 1991 Gulf War, the United States received criticism for waging "a war for oil." However, following the shale oil revolution in the 2000s, the United States has emerged as the world's largest oil producer. Its energy dependence on, among other regions, the Middle East has declined, and in the world facing the war in Ukraine, it is one of the few countries capable of exporting LNG. Furthermore, the resumption of nuclear power generation and the spread of renewable energy will ensure that the United States will achieve "Energy Independence," a long-standing challenge for the country.

5) Allies and friends: The hegemonic United States has many allies and friends. On the Atlantic side, it has an ally in NATO and Israel, and in the Indo-Pacific region, it maintains alliances with Japan, South Korea, Australia, and Southeast Asian countries. With Latin American countries, it signed the Inter-American Convention of Mutual Assistance. Those allies and friends could constitute invisible yet beneficial assets for the United States to lead the world.

6) The dollar standard: Although not as omnipotent as it used to be, the US dollar is still the world's key currency, accounting for just under 60% of foreign exchange reserves in other countries. US government bonds are considered to be the safest asset in the world, with $7.4 trillion out of the $31.4 trillion debt (as of April 2023) owned by Japan and other foreign countries. In recent years, however, Washington has too often resorted to financial sanctions as a diplomatic tool; as a result, an increasing number of countries are avoiding the US dollar.

Given these apparent advantages, there is no room for doubt about the US economy's medium- to long-term superiority. The US economic supremacy stands out especially when compared to China. 1) China has already entered a population decline due to its low birthrate and aging population. 2) There is a deepening divide between state-owned enterprises and private companies. 3) There are wide disparities among regions and cities. 4) The country is far from being self-sufficient in energy. 5) Its only ally is North Korea. 6) The internationalization of the renminbi still has a long way ahead to go.

These advantageous elements are, so to speak, "capabilities," and the US economic "performance" is exerted by multiplying these capabilities by the "will" of the nation. It is just like however powerful weapons it may possess, any army cannot win a war if it uses them poorly.

Allow me to cite an example associated with 6) The Dollar standard. Fitch Ratings Ltd. announced on August 1 this year that it had downgraded the US government bond rating from AAA to AA+. When they notified the US government in advance of the downward rating, reportedly, Fitch referred more than once to the "January 6 incident" or the attack on Congress by supporters of former President Trump. Fitch identified a "deterioration of governance" in America as one of the reasons for the downgrading. On the same day, Trump was indicted by a federal grand jury for his involvement in the incident. Special prosecutor Jack Smith, appointed by the Justice Department, said the Capitol riot was "an unprecedented attack on the heart of American democracy."

Ironically, the lawsuit seems to serve to further unite Trump supporters. The exact same phenomenon occurred at the time of the two previous indictments against Trump. The radical polarization of public opinion has made US politics dysfunctional. Fitch's decision to downgrade US government bonds was affected by US politics rather than by the US economy.

On June 2, the House and Senate passed the "Fiscal Responsibility Act" by unexpectedly large margins, postponing the debt ceiling issue until January 2025 after the next presidential election. It was undoubtedly a desirable result for the US economy, but whether it will improve the US fiscal situation is another question. The US economy will continue to grow; revenues may increase to some extent. In the meantime, however, Republicans will continue to seek tax cuts, whereas Democrats will continue to claim expenditure increases. Since the Fiscal Responsibility Act did not touch the debt ceiling question, the US debt will have increased much higher than the $31.4 trillion legal limit when the debt ceiling becomes binding in January 2025. No matter how robust the US economy is, we should not put too much faith in US government bonds when the American political situation is like this, should we?

To offer an analogy, the US economy resembles a card player having a good hand in the game—it is blessed with talents, money, technology, resources, innovation, and numerous friends. Yet, if the player plays his cards wrong, he will end up not making the most of the good hand.

Arthur Kroeber is an American economic journalist who has lived in Beijing for many years to cover the Chinese economy and US-China relations. In his recent book, "China's Economy," he asks himself whether China will replace the United States. 5 Kroeber's judgment is as follows: "China will never be content to be a U.S. vassal. But in the long run, it may lack the capacity to dislodge the United States from its dominance… assuming that the U.S. acts wisely to shore up its own strengths, a proposition that is now open to much doubt."

In sum, when discussing the medium- to long-term outlook for the US economy, we must focus on what are the US government's aims and whether its efforts will succeed.

3. "Restoring the Middle Class"—Top Priority Challenge for the Biden Administration

On April 27 this year, National Security Advisor Jake Sullivan delivered an economic speech at the Brookings Institution entitled "Renewing American Economic Leadership." 6 "A security expert talks about economic issues. Why?" Sullivan's speech attracted the attention of Washingtonians.

Sullivan states that the United States is facing four crises (a hollowing industrial base; geopolitical competition; climate crisis and energy transition; widening inequality and a crisis of democracy). He calls for a "new Washington consensus."

This speech indicates that the Biden administration considers "domestic and foreign policy" and "the economy and national security" as things inseparable and prioritizes "restoring the middle class."

Sullivan participated in the Carnegie Peace Foundation research project "Making U.S. Foreign Policy Work Better for the Middle Class" (2017-2020). 7 After interviewing across the country, the project highlighted that US foreign policy was not supported by the middle class at home. The project recommendations conclude that future US diplomacy must pursue a "less ambitious foreign policy," prioritizing restoring the middle class.

Joe Biden, then a presidential "candidate," "bought the idea in its entirety." After winning the presidential election, he selected Sullivan as his national security advisor and made "foreign policy for the middle class" a principle of his administration.

How, until then, had the middle class viewed US foreign policy? The Carnegie report discusses various types of past foreign policy and declares that none of them benefited the middle class. Trump-style "America First" diplomacy and "climate change-obsessed" diplomacy as espoused by the radical left, are curtly dismissed.

Furthermore, "pro-business" and "pro-globalization" approaches, which have long constituted the centerpiece of US foreign policy, are also dismissed. In other words, diplomacy that promotes globalization and favors big business is not judged to benefit the middle class.

There was a time when the CEO of General Motors boastfully said that "what is good for GM is good for the United States"—the good old days when corporate prosperity brought wealth to the nation, which, in turn, led to individual happiness. Today, such a phrase is not at all based in. No matter how platform companies like GAFAM prosper, they do not add many jobs, their revenues evaporate, or they do not contribute to tax revenues. They move their manufacturing and research bases overseas and take little interest in increasing employment and wages at home. In other words, the interests of corporations, the state, and individuals do not overlap as much as they used to.

That said, if the Biden administration were to say, "The goal of our diplomacy is to raise middle-class wages," that would end up sounding a lot like "America First," "Buy American," namely, Trumpism. The Inflation-Reduction Act (IRA) and the CHIPS Act, which the Biden administration enacted last year, are protectionist laws that favor EV and semiconductor investments in North America but are discriminatory against extra regional products.

The EU initially reacted strongly against the IRA prioritizing US manufacturers. Eventually, however, the EU chose not to make matters worse; it may have reasoned that going green is an important issue whereas the WTO rules have already lost substance. The EU has shifted to a policy allowing its member states to provide domestic subsidies—with their eye on China. The country is already the world's forerunner in the production of EVs, which the EU emphasizes most. This is due, in large part, to the Chinese government's extraordinary domestic subsidies.

Reading between the lines of Sullivan's Brookings speech, his criticism seems to point at the Clinton administration of the 1990s rather than the Republican Party. Sullivan states that further tariff reduction will not be sought. He probably believes that trade liberalization during the Clinton administration, such as the launch of the WTO, China's accession to it, and the ratification of NAFTA, led to the downfall of the US middle class. Today's Democrats regard the neoliberal policies of the Clinton era as the paramount "evil."

On the Brookings Institution's website, many experts comment on Sullivan's speech. 8 Professor Larry Summers, Secretary of the Treasury under President Clinton, notes, "[W]e have 60,000 people working in the steel industry and 6 million people working in industries that use steel." He argues that cheap imported steel should be more beneficial to the US economy and that more emphasis should be placed on consumers and service industries, not manufacturing industries alone. This is the argument that an economist might make. If Sullivan were a student majoring in economics, Professor Summers might not hesitate to give him an F.

From a purely economic perspective, Sullivan's Brookings speech resembles a student's argument downplaying the market. It is well known that today's Republican policies swing to the far right, whereas Democratic policies are leaning too much to the left.

As a result, "Bidenomics" and "Trumpism" look surprisingly similar. However, as far as protectionism and industrial policy are concerned, Bidenomics is arguably more sophisticated. Edward Luce of the Financial Times outspokenly comments: "Biden's policy is Trumpism with a human face." 9

Nevertheless, the Biden administration aims to "restore the middle class." The middle class is considered to share converged political views due to its similar living standards. In a democracy, public opinion is more important than popular sentiment. Unless the "thick middle class" is restored as the political "center," US foreign policy will lose its orientation.

In today's American political scene, however, there is a minute division of principles and opinions in terms of generation, educational level, living place, race, gender, etc. The spread of SNS is also accelerating the polarization of people's consciousness.

The Biden administration is attempting to win back the support of the middle class, especially the white blue-collar class that supported Trump, by increasing domestic investments in semiconductors, renewable energy, and infrastructure; by creating more good-paying jobs. On the other hand, former President Trump fares well with white-blue collar voters by speaking for their "ressentiment."

Neither path seems to lead to a genuine "restoration of the middle class." The US economy is unlikely to escape this scheme of confrontation in the foreseeable future.

4. Where the US-China Semiconductor War Goes

Although the US economy has excellent fundamentals, US politics is so "ailing" that it is questionable whether the United States can behave sensibly. A return to globalism in a Biden presidency is questionable. For example, the prospects for the US re-entering the TPP under the Biden administration should be considered almost zero.

In this context, how should we view the current US-China confrontation? In his Brookings speech, Sullivan declared protecting US fundamental technologies from China with a "small yard, high fence" strategy or introducing regulations ("high fence") only in the area of cutting-edge semiconductor technology ("small yard"). According to the speech, the US government will not meddle with other private businesses but will welcome increased bilateral trade. The speech includes the fashionable phrase, "[W]e are for de-risking and diversifying, not decoupling." 10

A decoupling between economic superpowers like the United States and China is unrealistic. Above all, US companies would not follow government instructions. Silicon Valley and Wall Street companies maintain ties with Chinese firms in various ways. They are working to benefit their shareholders, not allowing for the government's intentions as their Japanese counterparts do.

The narrowing of the battlefront with China to the "small yard" may be seen as a conclusion that the United States has reached after years of trial-and-error efforts in the form of hard-line measures against China—tariff hikes, investment restrictions and sanctions against individual Chinese companies including Huawei.

The present author believes that the United States began to adopt a tougher stance toward China in 2015, toward the end of the Barack Obama administration. The following factors may have combined to create consensus within the Washington policy community:

  • Security: In 2014-15, China's military buildup in the South China Sea continued. In response, the US military began the "Freedom of Navigation Operation" in 2016. In July 2016, regarding a China-Philippines dispute, the Permanent Court of Arbitration in The Hague ruled that "China's claim of its ‘nine-dash line' is groundless."
  • Trade policy: In his January 2015 State of the Union address, President Obama declared accelerating TPP negotiations to prevent China from "writing international rules." China responded by creating the Asian Infrastructure Investment Bank (AIIB) to increase its peers in the world of international finance.
  • Environment policy: In November 2014 in Beijing, President Obama and President Xi Jinping issued a US-China Joint Statement on Climate Change. The US-China agreement opened the way for the "Paris Agreement" to be enacted at COP21 the following year. This meant, in a way, that the United States must no longer give "unnecessary consideration" to China.
  • Science and Technology: In July 2015, China announced "Made in China 2025." Its goal was to "transform the country into the world's top manufacturing powerhouse" by 2049, the 100th anniversary of the founding of the PRC. Industrial policy approaches like this are not unusual in China, but "Made in China 2025" features focus on areas such as robotics, semiconductors, and AI; huge amounts of money were invested in relevant technological development.

The United States had another motive for accelerating its hard-line policy toward China during this period. Chris Miller's best-selling book, "Chip War," elaborates on this.

The book depicts the years around 2015 as the turning point when Intel, a US semiconductor giant, lost its competitiveness and gave up its rivalry with Taiwan's TSMC. 11 From this point, the United States could no longer count on "Intel that forgot innovation."

From the late 1990s, Intel enjoyed the effortless sale of its semiconductor products because Microsoft's Windows PCs running Intel chips sold incredibly well. However, smartphones were to replace PCs as major chip-consuming products, supporting a massive demand for cutting-edge semiconductors. Apple put its first iPhone on sale in 2007.

Since then, Apple has introduced new products at two-year intervals, each time requiring more advanced semiconductors, for which TSMC received orders. The Taiwanese chip giant was obliged to make massive investments in developing semiconductor miniaturization technology. Fortunately, Apple generously provided the necessary funds because its iPhone flew off the shelves. Thus, TSMC became the foremost supplier of cutting-edge semiconductors.

Ups and downs are an everyday thing in the semiconductor industry. Whenever new semiconductor demands emerge, old players drop, and new ones rise. The rise and fall of Japanese semiconductor manufacturers in the 1980s and 1990s is an example. The vicissitudes of Intel embody the "all-that-is-fair-must-fade" principle in this industry.

Meanwhile, US policymakers took it seriously that the United States could no longer produce semiconductors on its own. Their anxiety was further amplified by supply chain problems and a global shortage of semiconductors during the COVID-19 pandemic. Even if the United States can design cutting-edge semiconductor products but must depend on other countries for manufacturing them, such a situation is bound to threaten her national security.

In terms of economic logic, the correct solution would be to maintain domestic high-value-added sectors and outsource low-value-added sectors to other countries. Managers of semiconductor foundries in Taiwan used to keep a low profile, citing the "smile curve" logic and saying, "Ours is the lowest value-added sector." 12 Ostensibly, semiconductor foundries are in a vulnerable position, but this is not the situation. Once the semiconductor manufacturing process became so sophisticated that the influx of new entrants stopped, they came to dominate the trade.

In December 2022, TSMC announced that it would build a sophisticated 3-nanometer process plant in Arizona and begin production in 2026, which superficially suggests that TSMC succumbed to America's protectionist CHIPS Act. However, this is not the case; investments in the United States would serve as the ultimate insurance for the Taiwanese chip giant in case of a Taiwanese contingency. 13 From the US government's point of view, on the other hand, this would be another "victory for Bidenomics."

Chris Miller's "Chip War" traces the birth of "chip" to the summer of 1958, when the idea of the integrated circuit was born. It has already been 65 years since then. It can be viewed as a kind of miracle that the famous Moore's Law (the number of transistors in a dense integrated circuit doubles about every two years) has continued to be valid during this stretch of time.

The semiconductor industry is the poster child of globalism; human resources, goods, money, and technology—brought from around the world by the industry—have made the above miracle possible. However, under the current US policy of protectionism, such as the CHIPS Act and "friendshoring" or the practice of completing the supply chain of semiconductors only among friendly countries, the kind of technological innovation that has been realized to date would no longer be possible.

As long as there is a bipartisan consensus in the US Congress to "reject globalism," it is hard to have a positive outlook for the world economy. The United States may be able to stop China's adventurism, which, however, would be accompanied by no small amount of sacrifices. The costs may include lower global growth rates, inefficiencies, price hikes due to double investment, stagnant trade due to frequent trade frictions and staying-high tariffs, and delayed technological innovation.

As an aside, the political challenge of restoring the middle class will not be easy to realize.

5. Conclusion

As if to mock the author's pessimistic observation, the semiconductor industry is booming with "generative AI." To borrow an expression from the Economist magazine, "As in the early days of any gold rush, though, it is already minting fortunes for the sellers of the requisite picks and shovels." 14

In other words, it is uncertain whether attempts like "chat GPT" will succeed; challenges await ahead, such as how to create a profit model and how to deal with future regulations. Nonetheless, generative AI is indisputably a breakthrough technology; huge investments have already been made in producing the semiconductors needed for its development. Since smartphones are already a mature product, generative AI will instead support demand for semiconductors for the next decade or so.

This is the market mechanism and the inherent dynamism of the economy. The economy continues to change and develop beyond human wisdom. Since olden days, politics has never successfully controlled the economy.

If I dare to answer for now the question posed at the outset of this paper, I want to bet on the possibility that the US economy will emerge as the final victor, despite various wrong decisions made by politics.

(Chief Economist, Sojitz Research Institute, Ltd.)

(Translation by Tsutomu Inuzuka)

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