The U.S. can believe it’s going to suppress [Chinese manufacturing] and take steps to suppress and contain it, but it’s preordained to fail.
Parag Khanna, author of forthcoming book The Future Is Asian

In the last Dismal Optimist, I took the cautiously optimistic view that Trump would need to make a deal with China in order to get reelected and that this deal would signal a bottom for the global stock markets. I continue to adhere to this view. It appears that the markets are indeed rallying in anticipation of such a deal.

But there is a dark cloud on the horizon which the markets apparently have ignored thus far. That cloud is the Export Controls Act of 2018. This Act extends export controls to what the Act calls “emerging and foundational technologies”. The public comment period on the new rules closed on January 10, 2019. Reportedly the Act would expand export controls to 14 areas of new technologies with an ostensible eye toward national security. These areas include artificial intelligence, robotics and biotechnology.

The Act is a product of the anti-China hysteria that has infected the US government and is a grotesque expansion of government powers. It’s impossible to know how draconian the enforcement of this Act will be. But this is incredibly important. Technology, including products like the Apple iPhone which are designed in the US but manufactured elsewhere, is the most important US export.

Thanks to the Export Controls Act of 2018, there is considerable worry about the reliability of US technology supply, especially in Asia. Technology is a global phenomenon with myriads of interlinked supply chains, personnel and investment flows. There are fears in Asia that the US will try to wall of its technology by extending export controls on a wide variety of so-called sensitive technologies. This would have widespread negative effects on US tech companies as well as companies not just in China but also Taiwan, South Korea, Japan and Singapore.

A recent article regarding the Export Controls Act in the Nikkei Asian Review entitled US Move to Wall Off Tech Unsettles Asian Companies summarizes Asian fears and the potentially disastrous effects of this Act. Remember – the Asian companies are US customers.

To cite a few examples of where there could be problems. Any exports that would transfer targeted technologies to China or other nations considered security threats would require American approval. This might include development of products in China that use U.S. patents. Wow.

Another example. Many Asian manufacturers rely on cross-licensing agreements with American partners. “There are many semiconductors that we simply can’t produce without U.S. patents,” an executive at a Japanese chipmaker told the Nikkei Asian Review.

Yet another example. Asian companies frequently have research facilities in the United States. Suppose a Japanese auto company does research in the US for technology that will be used in China. Will that technology be allowed to be used in China?

And finally what about Siri and the other personal assistants. Siri’s AI. The Chinese might learn something. Shut it down?

The list of potential examples is endless. Nobody knows how strictly the criterion of national security will be interpreted.

Congress must stand up to the national security mythology. As we have seen with Trump’s imposition of tariffs and maybe now the Wall, national security is a very elastic concept where intellectual honesty has no role. US anti-China hysteria can run amok here, especially in Congress. The Export Controls Act of 2018 has the potential to gravely damage the tech industries of the US and its Asian Allies.

As I have argued in prior Dismal Optimists, the demand for new technology is predominantly a civilian one. Global consumer and business demand simply dwarfs the military demand. China a major source of demand. All technologies are dual use, i.e., they have civilian and military uses. The American technology growth engine will stall if it is denied the world’s second largest economy as a market and its products and technology cannot be used by allies like Taiwan, South Korea, Japan and Singapore. And American stock prices will drop like flies.

The American bottom up free market system is where the best and the brightest compete and the entire world is its market. America is number one in technology because it is free market bottom up, unlike China. The Export Controls Act of 2018 is a top down – frankly un American—statist measure that will damage the American tech sector. It has been passed by a Congress that doesn’t understand technology (witness the farcical Facebook (FB) and Google (GOOG) Congressional hearings) or the role of global markets in driving technology. The Act would impose a regime that would resemble the much-derided Indian License Raj whereby in India so many economic activities required the permission of a (corrupt) state to exist.

And if the Act is enforced rigorously, it will demonstrate to the world that America is an unfair and unreliable supplier of technology. Trump complained about Germany allowing itself to become dependent on politically unreliable Russian gas. This would be worse.

Indian American author Parag Khanna, quoted above, is already predicting that the massive Asian economies will turn away from an indifferent and unreliable US. Khanna believes that the U.S.-China trade war will accelerate the integration of Asian economies and further diminish America’s role in Asia. This will seriously harm U.S. companies that do business with China.

If Trump wants the stock market to go up, he’s going to have to keep this Export Controls Act dog on a tight leash. Better yet. Get rid of it.

China Should Not Be Treated Like the Soviet Union or Cuba

One of the ringleaders of the anti-China campaign is Florida Senator Marco Rubio. Rubio thinks Chinese students in the US are spies. He advocated putting ZTE (ZTCOY) out of business by continuing the ban on selling ZTE equipment. He supported the students who disrupted Hong Kong several years ago. And he has claimed China was developing special biotech weapons to use against the United States.

Rubio’s attitude is perhaps understandable. His parents emigrated from the failed prison of Communist Cuba. He thinks China is a big Cuba. Rubio has some very sensible things to say on other subjects. (Despite years of living in Hong Kong, I’m officially a Florida resident. I actually voted for him.) But Rubio and his fellow Congressional travelers are wrong on China.

First Cuba is an economically unimportant small Caribbean country whose off-limits status for US companies makes little or no difference to the global economy. China on the other hand is the world’s second largest economy with a vibrant private sector with firms like Alibaba (BABA), Tencent (TCEHY) and Baidu (BIDU). The US cannot afford to treat China like Cuba.

Second, the Soviet Union was dedicated to the spread of world communism. With justification it was considered to be a threat to the West including the United States. Despite its official status as a communist country, China espouses no messianic mission of spreading global communism.

Third, China is a high intelligence nation with a long tradition of learning. In Imperial times and under the Confucian social order scholars were on the first rung. China is hell bent on reclaiming its former stature in the world and hell bent on becoming a technological superpower. Those are perfectly understandable goals. Talented Chinese students studying STEM subjects are prominent at universities around the world. China is a technologically obsessed nation. It should be no surprise that China would want these students back in China. It should not have to apologize for its Thousand Talents Program which is designed to get Chinese students to return. What is not understandable is the US reluctance to compete and make it easy for these talented Chinese students to stay in the US after graduation. Chinese graduates who have managed to stay in the US are quite prominent in Silicon Valley and have made significant contributions to the American economy. There is a global competition for brains. Or does the US attitude reflect the persistence of historical anti-Asian prejudices in the American national psyche? The treatment of Asians that prevailed historically in America until the end of World War II was especially ugly.

Fourth, dictatorships thrive on isolation. Cuba and North Korea are classic examples of isolated dictatorships that go on and on. Isolation has failed as a policy. Isolating China will simply encourage dictatorial tendencies in its political system.

Fifth, the view that technology is liberating may be out of fashion but it may still be right. A censored Baidu or Tencent is better than no Baidu or Tencent at all. (A censored Google could have provided competition for Baidu. It was a mistake for Google not to reenter China.) Travel, study and the internet have made the Chinese people more aware of the outside world. Current Chinese tendencies towards more state control may eventually be reversed by continued tech driven prosperity. There is the example of South Korea, a technologically advanced nation, that went under dictatorship from the ashes of the Korean War to a Western style democracy today.

Sixth, imagine for a moment China had a Western style democracy as a government. I contend that China’s international behavior would not be that different than today. China would still demand the return of Taiwan. China would still assert its perceived rights in the South China Sea. China would still demand the return of the Senkaku/Diaoyu islands from Japan. China would still have some version of the Belt and Road Initiative. And China would certainly be a contender longer term to become the world leader in tech. Ironically, a hypothetical freer more market oriented Chinese economy would be even stronger than the current real one.

The US has to come to terms with the rise of China in a non-belligerent fashion. Both countries are nuclear powers. Chinese dynasties have risen and fallen over the last five thousand years. The current nominally Communist dynasty is in a rising phase. Chinese dynasties typically last for hundreds of years.

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