Remarks by Henry M. Paulson, Jr., on the Risks of an “Economic Iron Curtain”


Media Contact:
Claire Buchan Parker: claire@cbcommunicationsllc.com

February 27, 2019—Washington, D.C.—Henry M. Paulson, Jr., Paulson Institute Chairman and 74th Secretary of the Treasury, today addressed the Center for Strategic and International Studies (CSIS), during which he elaborated on the concerns he expressed last fall about an Economic Iron Curtain and the impact of recent changes to investment and export control regimes and their effect on innovation and technology-related trade and investment. Below are Secretary Paulson’s prepared remarks.

 

Thank you very much, Fred.

And Ladies and Gentlemen, thank you for joining us this morning for what I’m certain is going to be an intensive half-day of discussions and exchanges.

To get things started, let me send you off into your three breakout groups by being as blunt as I know how to be:

You’re going to face an incredibly big challenge.

For one, the trade debate in this city has changed markedly from just five years ago, much less from when I served as Treasury Secretary.

On both sides of the political aisle, leaders and legislators now question the benefits of trade.

Across our political spectrum, from left to right, many argue that America has been taken for a ride.

For others, the problem isn’t trade but rather trade agreements. They question the way that trade policies and practices have been conducted in recent decades by administrations of both parties.

In fact, politicians on both sides are actually applauding for tariffs—something, quite frankly, I never believed I’d see.

America’s approaches, policies, and posture toward international trade are in play. And trade risks becoming a political football as the presumptions that once drove American policy come under question from all sides.

Republicans and Democrats swat at the decisions and actions of former administrations of both parties.

Meanwhile, out where I live—in the Midwest, in the heartland of America—a lot of people still depend on trade, both exports and imports.

And that dependence is growing.

They’re crying out for solutions, not political sniping.

Above all, they’re crying out for access to, and more opportunities in, foreign markets — because that’s where so much future growth is and where opportunity lies. And that’s why expansion into foreign markets is essential to their growth strategy.

Frankly, some of them are also hurting.

So they’re starting to wonder if there’s a way forward that means opportunity, not hardship.

They want leaders who deliver.

And so the title of today’s event—“a positive trade agenda”—is both timely and important.

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Now, it’s no surprise that one of your three breakout groups is focused on China — because it’s China, after all, that lies at the epicenter of our current trade debates.

And people are rightfully focused on US-China trade negotiations. My view is China can agree to enough of what President Trump seeks to enable a deal that includes some meaningful structural changes and intellectual property protection and one that the President can be proud of if it contains compliance and enforcement mechanisms to ensure implementation. 

And that would be a significant win.

But I also happen to believe that even assuming a successful trade agreement, the underlying tensions will persist and will be particularly intense in technology related trade and investment.

And that is what I want to talk about this morning.

Some of you may know that I gave a speech in Singapore last November in which I warned that “an economic iron curtain” is a very real possibility as a result of a decoupling between the United States and China.

Sadly, nothing that has happened since November has changed my view or softened my concerns.

That is a function, first, of Chinese choices.

Second, it reflects certain American choices.

Third, it is because national security concerns are now bleeding into virtually every aspect of our economic relationship.

And fourth, it reflects the reality and intensification of strategic competition between the United States and China. 

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The United States and China have always had a turbulent relationship.

And that turbulence—the cyclical ups and downs in US-China relations—has never gone away.

But I believe, now, something of deeper significance is happening.

We are moving beyond cyclical ups and downs.

A variety of structural factors and serious policy and strategic disagreements have fueled the emerging consensus that China is not just a strategic competitor but very possibly our major long term adversary.

Nobody is arguing against dialogue.

But nearly everybody in the United States is arguing that the results of dialogue have been poor.

In large part, because China has been slow to open its economy since joining the WTO, the American business community has turned from advocate to skeptic and even opponent of past US policies toward China.

American business doesn’t want a tariff war but it does want a more confrontational approach from our government.

And against that backdrop, we must look warily at the prospect that what, until now, has been a healthy strategic competition could head in directions that tip us into a full-blown cold war.

I spoke at length in Singapore about how we arrived at such a moment of heightened tension, with a big emphasis on Chinese policies, practices, and behaviors. So today I want to lay out what I view as the biggest risks, especially for the United States.

And I’ll make a few modest suggestions as to how to begin the long process of setting US-China relations onto a more sustainable footing.

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First, the risks of an economic iron curtain are considerable.

And while many Americans like to talk about the risks to China, we need to face up to the fact that some of the policies now under debate in this city pose considerable risks to the United States, too.

Here’s the nub of it:

The US-China relationship has been characterized by the integration of four things—goods, capital, technology, and people.

And over forty years, economic integration between the two countries was supposed to mitigate security competition. 

But an intellectually honest appraisal must now admit both that this hasn’t happened and that the reverse is taking place:

And technology is the critical driver of this change.

In today’s world, technology is an integral part of business success, blurring the lines between economic competitiveness and national security.

The result is that, after forty years of integration, a surprising number of political and thought leaders on both sides advocate policies that could forcibly de-integrate the two countries across all four baskets.

The integration of trade in goods could come undone — as supply chains are forcibly broken, especially for those that use sensitive technology.

Integration through cross-border capital flows will come under ever greater pressure — as restrictions on Chinese investment take hold across big sectors in the United States.

The integration of people, especially the brightest young students, could also stall — as Washington potentially bans Chinese students from studying for multiyear PhD or postdoctoral programs in whole categories of science and engineering subjects.

But most important of all, if this trend continues, we need to consider the possibility that the integration of global innovation ecosystems will collapse as a result of mutual efforts by the United States and China to exclude one another.

Some in the United States now advocate a Cold War-style technology denial regime.

And this is partly because of a growing consensus that China has been using policies and strategies that foster the indigenous development of high technology to set its own standards and, ultimately, pursue self-reliance.

Pervasive technology theft, forced technology transfer, including within joint ventures, and different models of internet governance and cross-border data flows are also contributing factors.

Yet innovation and technology cannot be separated from business competitiveness.

So, such a balkanization of technology could further harm global innovation, not to mention the competitiveness of American firms around the world.

But more than that, I am convinced that it has the potential to harm the United States in ways that too few people in Washington seem to take seriously:

They’re focused on finding ways to hurt China and attenuate its technological progress in advanced and emerging industries.

But they’re less focused than they should be on what that effort might mean for America’s own technological progress and economic competitiveness.

If this persists—across all four baskets of goods, capital, people, and technology—I fear that big parts of the global economy will ultimately be closed off to the free flow of investment and trade.

And that is why I see more clearly than ever the prospect of an Economic Iron Curtain—one that throws up new walls on each side and un-makes the global economy, as we have known it.

That is what concerned me in November.

And it remains my concern today.

The good news is that many of the changes that have been or are being made to America’s investment screening mechanisms and export control procedures were vastly overdue and, therefore, are quite appropriate.

Let’s just take investment.

I helped lead the 2007 effort to reform our national security investment review process—or in Washington acronym speak, CFIUS—because I felt strongly that it needed to be updated to reflect new challenges.

And since I never thought the CFIUS process should be static, it won’t surprise you to know that I also welcome the more recent updates to FIRRMA—the Foreign Investment Risk Review and Modernization Act—which have continued that necessary process.

One thing that was overdue was to subject critical infrastructure and sensitive data, not merely controlling stakes in companies, to a process of review, screening, mitigation, and occasional rejection.

And that is why, generally speaking, I also welcome elements of a wisely implemented ECRA—the Export Control Reform Act—which is necessary to update our export controls.

Every American business and innovation leader that I talk to welcomes the prospect of strengthened vigilance to protect our national security, and closer government-industry collaboration to do just that.

Every one of them hopes it will lead to robust, strong, and enduring American leadership.

But these business and innovation leaders worry too.

They worry about the vast scope of the restrictions.

They worry that we will fail to define “emerging” and “foundational” technologies with care.

They worry that government bureaucrats, who do not fully grasp all of the dimensions and applications of the technologies at stake, will administer controls with a blunt hammer without fully considering all of the consequences of their actions and the collective impact on our nation.

They worry that, ultimately, we risk walling off whole classes of knowledge, technology, and innovation.

And they worry that this, in fact, will backfire—undermining American innovation leadership while China and others continue to jointly innovate with one another.

 So while, of course, we need to handle components that are made in China with particular care—and while we need to be eternally vigilant on national security grounds—we also need business and government to work together with wisdom and care.

The problem with applying a blunt hammer is that it can end up breaking everything.

If you aim to hurt others but end up hurting yourself, you cannot always recover for a second chance.

 In one potential scenario (or in the extreme case), we could end up sequestering so much important technology in the United States that American companies no longer participate in international supply chains for the fastest growing industries.

 What would that mean for us?

For one, America would abdicate a role in setting global standards in key industries.

For another, the US innovation engine would lose its place as the world’s most attractive investment destination.

And that is because, as my friend and former Bush Administration colleague Dan Price of Rock Creek Global Advisors says, the ultimate Silicon Valley prize is the next unicorn and that unicorn won’t be as attractive if it can only graze in America.

Now, as a practical matter, rather than an aspirational one, China still relies a lot on global capital, trade, investment, and foreign know-how.

And so the most strident calls for “decoupling” are actually coming from the United States and, to a lesser extent, from Europe, not from China – although China, it is true, is now taking urgent steps to try to indigenize its supply chain, something that some in that country have always urged.

But here’s the problem for those in our country who advocate a US-China “divorce”:

“Decoupling” is easier when you’re actually a couple.

But the United States and China are not, in fact, a couple. There are more than two players here. And the rest of the world gets a vote.

For instance, I do not believe that any country in Asia can afford to divorce China, or even wishes to.

And that may explain why the United States is getting more traction with its confrontational approach in the G7 economies of Europe and Japan than in the G77 economies of developing Asia, Africa, Latin America, and Oceania.

Like the United States, some other advanced industrial democracies may now seek to strip Chinese equipment out of backbone technology systems.

But most, if not all, developing economies will not. And the signs from some of America’s closest partners, including Britain, Germany, and Israel, are—at best—ambiguous.

And so in its effort to isolate China, the United States risks isolating itself.

Frankly, de-integration is inevitable, and even necessary, in some areas—to protect our national security.

But it is decidedly not in America’s interest to attempt this across the board.

Divorce doesn’t work well for global businesses.

And the same could be said for the trade policies that drive companies and countries away.

So instead of pursuing a carefully calibrated de-integration—focused on sensitive and critical areas—the US seems instead to be flirting with a comprehensive de-integration.

And through initiatives like technology policies that are designed to isolate China from the supply chain, Washington risks, as I said, sequestering technology in the United States by isolating itself from global supply chains in the fastest-growing economies.

And Washington is at risk of more battles with its allies and partners—the very partners it needs to help alter Chinese behavior. 

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Of course, if China wants to keep its relationship with the United States from spinning out of control, it is going to have to look hard at some of its choices and policies.

And so I continue to encourage China’s leaders to pursue reforms in three baskets in particular:

The first is competition reforms.

Foreign firms need to be allowed to compete with Chinese firms on a level playing field.

The second area involves the role of the market.

China will always have a large state-owned sector, of course.

But China should strengthen those pillars that permit firms—even the state-owned firms—to be run commercially.

That means strengthening corporate boards, not Communist Party Committees, as the tool of external supervision.

Third, China must foster and protect innovation.

Policies of forced technology transfer should end. China should work to prevent cyber-theft, and better protect intellectual property. And a mandate for indigenous innovation should not be used to limit competition, including through the use of standards.

If China doesn’t move very quickly indeed, I suspect the calls for divorce will intensify.

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Ladies and Gentlemen, I don’t believe the current trajectory can be easily reversed.

To alter the downward spiral, thoughtful people need to make some tough decisions.

To get things started, I offer, as I have before, some simple prescriptions for American policymakers:

First, dial down the rhetoric.

Strategic competition is a fact.

We have compelling differences of national interest between our two countries and we should prepare for the obvious strategic challenges from China. But in doing so, let’s not sacrifice those values—or the commitment to openness—that has made us the strongest, most competitive, and most admired country in the world.

Second, enlist partners. And then, working in coalition with these partners, try to foster some workable understandings with Beijing.

To be blunt about this, I wish President Trump would reconsider his decision to withdraw from the Trans-Pacific Partnership.

A TPP 2.0 would offer a ready-made vehicle to shape the trade environment in which Beijing operates.

Third, negotiate with China in a tough-minded way.

That means finding frameworks not just to discuss issues but resolve them — and then ensure compliance, as the Trump Administration is working to do.

And resolving them almost certainly means working in closer coordination with like-minded partners.

Fourth, and under any scenario, invest in America—big time.

A strong military.

A strong economy.

Strong educational institutions.

Strong investments in science and engineering.

Openness to the world.

Investment in alliances.

Investment in security and economic partnerships on every continent, but especially in Asia and Europe.

These things are essential if the United States is to compete and thrive in the world of the 21st century.

There is simply no substitute for getting our own policies right.

Today’s world looks nothing like the world of the 1970s, or even of the 2000s.

New technologies, new economic challenges, new geopolitical challenges – all of these have eroded the frameworks of the past.

And so we’ve reached another of those consequential moments.

And the stakes—for our economies, and for the world—are higher than ever before.

We need to craft a new framework that works for today’s world, not the world of the past.

And for that, we will need statesmanship—wise and strong leadership in Washington and Beijing.

Thank you.

 

About the Paulson Institute:
The Paulson Institute is a non-partisan, independent “think and do tank” dedicated to fostering a US-China relationship that serves to maintain global order in a rapidly evolving world. Our focus on US-China is dictated by the reality that it is the most consequential bilateral relationship in the world. We often operate at the intersection of economics, financial markets, environmental protection, and policy advocacy, in part by promoting balanced and sustainable economic growth. Founded in 2011 by former Treasury Secretary Henry M. Paulson, Jr., the Institute is based in Chicago with offices in Washington and Beijing.

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