Yes, it is a liability, because in exchange for your reserve currency status you are indebting your country. Gradually, as you outsource more and produce less, your country derives more and more of its returns from soft economic assets (financial markets, legal structures, software, pharma, IP, etc.), than hard economic assets (commodities, energy, manufacturing, transportation, logistics, etc.).
In the long run, this hollows out your industrial base, drives income inequality (because labor is devalued when products/soft assets have zero marginal cost of replication), and defangs your country.
Said differently — vertical integration is the key to “innovation” in the abstract. You can see this with BYD.
With the above in mind, let’s say your goal as a country is to develop your industries so you can achieve vertical integration. Soft economic assets are easier to bootstrap once you have hard economic assets. If you lose your hard economic assets and only have soft ones, you are at a strategic disadvantage because your opponent (in this case China), can bootstrap their soft assets relatively quickly. By comparison, it will take you much longer to get your hard assets back (through the mythical process of “reshoring/reindustrialization”).
All that being said, this is not a commentary on the effectiveness of the tariff policy of the Trump administration.
Thanks for the explanation! Most of what you wrote makes sense to me. In particular, I think the concept that going hard -> soft economic assets is easier than the reverse is really interesting. I'll have to think on that more.
Things that still give me pause:
1. I don't understand why hard economic assets like manufacturing are more heavily impacted by this phenomenon. Wouldn't exporting a $50,000 car and a $50,000 software license have the same impact on the country's current account? I think it might have something to do with the marginal cost of replication point you made, but, for example, the marginal cost of manufacturing semiconductors is very small, and we trail in that too.
2. I disagree with your assertion that 'vertical integration is the key to “innovation” in the abstract.' I think this is often true, because vertical integration enables more control/flexibility and faster iteration, which allows innovation to occur. However, there are many cases (e.g. fabless semiconductors, meat poultry farming, software companies build on the cloud) where the innovation was actually to split the value chain into separate concerns with separate concerns.
1. The further you are up the chain of abstraction, the less “valuable” the export is as a form of power. Think of this as a spectrum between hard and soft assets — if you decline to sell advanced computing software to your rival, you may harm their ability to optimize crop yields, or whatever. But if you decline to sell them steel, or oil, you may decimate their energy supply and bring their economy to a halt.
So, generally speaking, harder assets have more “declination risk” for the purchaser than softer ones, because the softer ones are either a) at the tip of the value chain, or b) easier to clone and replace. China has done a great job of outright refusing US SaaS exports like social media companies, while “stealing” millions of Windows licenses from Microsoft.
Said differently, IP is fragile! If your opponent does not respect your laws, you can’t enforce them. Hard assets are the opposite, because you can more easily cut them off.
And again, they are usually at the bottom of the value chain, so everything else is dependent on them being available. No oil, no cloud computing. Not the other way around.
2. Great counterexamples. I think it depends on what you define as innovation, and perhaps more specifically what about innovation as a concept is important to you.
- There are “open” kinds of innovation that push humanity forward, grow global wealth and prosperity, and make everyone better off.
- There are also “closed” kinds of innovation that benefit only a particular group.
Generally speaking, open innovation is “fangless.” What I mean by this is that it does not greatly increase your geopolitical power. The Dutch, for example, own ASML, but this doesn’t really give them any power, because their tools are relatively “open”. Swiss companies own massive numbers of pharmaceutical patents, but that’s just a domicile on paper. If Switzerland were invaded tomorrow, their patent regime wouldn’t offer much protection.
By contrast, a more “closed” form of innovation (weapons manufacturing being the most extreme example) will dramatically increase your geopolitical power.
Think back to the atomic bomb. Now look to the future. If the US develops killer drone swarm technology, or genome-targeted bioweapons, or whatever else, that means we have the cards.
Once you have world (or space) domination technology, you can disproportionately benefit from it, and you can selectively enrich your allies by giving them access to it, like the US currently does with our weapons systems.
If you don’t vertically integrate, you can’t do closed innovation. And closed innovation is the only “hard money” — and perhaps the dominant power struggle in geopolitics.
That a Dutch company, ASML, commercialized a technology pioneered in America’s national laboratory ecosystem and largely funded by Intel also has important lessons for policymakers interested in protecting and promoting the next emerging technology.
Open innovation does not lead to geopolitical power.
There is one exception, which is that you can use your open innovation pipeline as a carrot to recruit intelligent people who then bolster your closed innovation ecosystem. The US used to be very good at this. We are still very good at this, but we're getting worse, and we're progressively more hostile to skilled immigration.
The Dutch and Swiss are very powerful, relative to their size. You can say fantasy things like "if they were invaded tomorrow", but that's not reality.
The US has atomic weapons, but has lost almost every war it has started since having nukes. Having weapons doesn't mean you will be faced with contexts to actually use them. "Genome-targeted bioweapons" is just made up nonsense. Just making up "if" statements of fantastical capabilities that do not have grounding in reality is just that: fantasy. Living in fantasy land is how the richest nation the world has ever seen could lose a war to teenagers in Afghanistan.
The idea of an "atomic bomb" would have seemed fantastical before it was developed. Bioweaponry is underfunded, far more dangerous than you think, and is a hot topic for the PRC [0].
And let's be clear — the US did not "lose a war" in Afghanistan or Iraq. Yes, we had failed pseudo-occupations. That is not the same as losing a war. No country, save perhaps Iraq during the Gulf War, has experienced the force of a modern American army. And if you want know what happened during the Gulf War, look at the "Casualties and losses" section on the Wikipedia page [1]. Spoiler: America won, Saddam lost.
You, and I, and the entire world, have been living under a Pax Americana for the past 70-something years. As that world order fractures, you will see that no country without hard assets and military power, the Netherlands and Switzerland included, are as powerful as they may seem.
Friedrich Merz, the incoming German Prime Minister, spoke very eloquently about this in his first televised conversation. Germany will lead the re-militarization of Europe (disclaimer: I am also a German citizen) [2].
> And let's be clear — the US did not "lose a war" in Afghanistan or Iraq. Yes, we had failed pseudo-occupations. That is not the same as losing a war.
You do not wage war for the sake of war, war is a tool for achieving political goals. What you're saying is that the U.S. won battles in these wars, but ultimately lost because they failed to achieve their political objectives — which were the very reasons the wars were started in the first place. They lost in Vietnam, Afghanistan, and Iraq. They lost all of these wars.
What were America's political objectives in those wars? There are stated and unstated objectives. We don't really know if they were achieved or not. Maybe Iraq was a Haliburton enrichment play... That's still going on [0]!
But you're not really right here. In both cases, American forces dismantled the initial enemy: the Taliban regime fell in 2001, and Saddam Hussein’s government collapsed in 2003. Combat superiority wasn’t the issue.
We "lost" because all of those wars were occupations. Locals just didn't care enough to keep us there, or vehemently opposed American presence. It's really, really hard to occupy a country that doesn't want you there, even if your military capacity is vastly superior.
Defending a nation like Taiwan or Japan is a totally different story. If you are defending a country from an external threat, they want you to stay.
I was responding to the above commenter, who wrote:
> Living in fantasy land is how the richest nation the world has ever seen could lose a war to teenagers in Afghanistan.
What I'm pointing out is that the US has extreme combat superiority that no country has ever had to reckon with. And we have never waged "total war".
Extreme combat superiority does not mean you are fighting a combat where that achieves your objectives. The reason the Taliban did not have to reckon with the full potential of the US military is because the US unleashing it's full power on them would be stupid. Your power is actually limited by the boundaries of rationality. The US (and to a lesser degree Russia) could in theory vaporize every city in any country, and kill everyone there. That's not actually a coherent goal (unless you like fantasizing about how powerful you are), and so it doesn't actually happen.
The development of nukes greatly reduced the possibilities of war between major nation states, and in the conflicts with minor states, nukes are not under consideration for use. Russia has never actually done any move with their nuclear weapon regiments to indicate using them, even though they are actively locked in a dumb war they underestimating that is costing hundreds of thousands of Russian lives. America kicked the Taliban out of power but could not keep the Taliban out of power, whether you left immediately or after 20 years. Your combat superiority doesn't mean you can defeat foreign militancies. Time and time again you have not defeated them. That is the reality. Fantasizing about unleashing the full combat superiority of the US military (nuking the entire landscape petulantly) to show that you are powerful is not a credible or coherent outcome... and lo it does not happen.
Finally, the US has waged total war since the end of WW2. Almost every substantial building in North Korea was destroyed in the Korean War. All of the dams and civilian infrastructure were entirely destroyed by US bombs. US bombers couldn't even find targets to indiscriminately bomb toward the end. And yet the US did not defeat the North Koreans.
(As a final note, DPRK started that war, not the US or its allies, so the primary objectives were inherently different and more defensive. Nonetheless, the use of total war did not achieve ultimate the victory it was aimed at.)
Right. You’ll notice I never mentioned WW2. I said this:
> You, and I, and the entire world, have been living under a Pax Americana for the past 70-something years. As that world order fractures, you will see that no country without hard assets and military power, the Netherlands and Switzerland included, are as powerful as they may seem.
And that is true! The Korean War was more than 70 years ago.
Since then, US military-industrial capacity has absolutely ballooned. Our modern military is orders of magnitude more capable, armed, and well-equipped than the one which fought the Korean War.
I don’t get what point you’re trying to make. Your arguments are redundant and make no sense.
With regards to military engagements, I’m explicitly talking about non-nuclear engagements, and I’m pointing out that states without true military capability will not be “live players” in the new world order.
You can see this with Ukraine and Russia! Military mobilization and aid has boosted the Ukrainian military to the second largest in Europe. If they didn’t have that aid and that military power, you can be sure Kyiv would be Russified tomorrow.
America didn't lose the Iraq War to Saddam, it lost to disparate groups of Islamic jihadis who read some Mao.
Losing a war is not body counts, it's a military withdrawal after a failure to achieve objectives. It doesn't mean there are winners.
America went into Afghanistan to destroy Al-qaeda and remove the Taliban from power. At the end of the war, the Taliban were back in power and global jihadism is even stronger and more pervasive than before. That is losing a war.
Pax Americana shows that big militarized states like the US and Russia (before that USSR) do not wield the operational war power they imagine. They lose every war they start (which, again, is not to say there is a triumphant winner).
In the long run, this hollows out your industrial base, drives income inequality (because labor is devalued when products/soft assets have zero marginal cost of replication), and defangs your country.
Said differently — vertical integration is the key to “innovation” in the abstract. You can see this with BYD.
With the above in mind, let’s say your goal as a country is to develop your industries so you can achieve vertical integration. Soft economic assets are easier to bootstrap once you have hard economic assets. If you lose your hard economic assets and only have soft ones, you are at a strategic disadvantage because your opponent (in this case China), can bootstrap their soft assets relatively quickly. By comparison, it will take you much longer to get your hard assets back (through the mythical process of “reshoring/reindustrialization”).
All that being said, this is not a commentary on the effectiveness of the tariff policy of the Trump administration.