Once one has climbed to the top of the hierarchy of the global division of labor, it really isn’t all that difficult to reach back down. However, if one has yet to make it to the top, getting there is extremely hard.
The US no longer manufactures most of what it buys, and many items it formerly manufactured are now being made elsewhere. But it’s not as if the US no longer has any economic activity. Much of that manufacturing activity was replaced by “higher level” knowledge work, part of which includes research and development that brings us such innovations as iPhones and this internet thing.
Despite the loss of manufacturing, one advantage the US has is that it can always decide to manufacture something if it wants to. All it has to do is throw money at the problem. The US rescue of General Motors is a case in point. It is quite likely that GM would no longer be building cars in the US if the US government had not determined to save the company. This is not to say the rescue of GM was necessarily a good strategy, just that, if the US government so desires, it has the wherewithal to pull it off.
China’s economy now provides a significant portion of the world’s manufacturing, a task for which it is currently well-suited. It has more people than it can count to throw at factories requiring unskilled labor. But an unfortunate disadvantage for China is that, whereas the US has the option of employing brute force (i.e., lots of money) to keep manufacturing onshore, China cannot simply employ brute force to encourage innovation.
Innovation is a higher level activity that requires a certain quality of education and a relatively free and open political environment. In absence of these requirements, China can throw all the money and slogans it wants at innovation and it will still not happen.
And this is why the US is in a far more favorable position relative to China. If, for whatever reason, all trade between China and the US were to stop for a period of time, not only could the US buy manufactured goods from other countries, but it would also have the option to begin rebuilding the manufacturing industries it once had. Again, while that may not be the optimal strategy, at least it is an option for the US. On the other hand, China, try as hard as it might, cannot become an innovative society without undertaking the kinds of political reform necessary to encourage innovation.
(And ironically, if China were to undertake such political reform, the probability of an interruption in trade between China and the US would quickly drop to about 0%, making this whole discussion more or less moot.)
To slightly oversimplify, while the US can do what China does, China cannot do what the US does. Not today.
But it is not as if China is a stranger to innovation. While my European ancestors were still banging sticks together, the Chinese were inventing cool things like gunpowder, the plow, the compass, paper. So I am quite certain the current lack of innovation is not an issue of human capacity, but more of a systemic one.
Of course, the bad news for Chinese citizens is that, in the short term, the system will not change. But the good news for many educated Chinese is that there is always the option of emigration to more innovative societies. Unfortunately for China, this is a double blow to the country as a whole. Nearly every educated Chinese who leaves is not only a minus-one for China, but also a plus-one for the country to which he or she immigrates.
The global hierarchy of the division of labor, as it currently stands, has brought the world both innovation and inexpensively manufactured goods. The current structure, despite its flaws, works pretty well, but a major problem China has with the current structure is that China is not in its traditional place on top. We can see this dissatisfaction in the central government’s continually unsatisfied demands for “indigenous innovation”.
For how long will insistence on rule by an unelected government continue to outweigh the Chinese desire to once again lead the world in innovation? For as long as China’s single greatest fear is instability. Until China's government can become comfortable with a little unpredictability, it should expect little in the way of breakthrough innovation.