There is a strong faith in science and technology in the West, but especially in the United States. I do not share it. My faith is in the religious, moral, cultural, and legal environment that puts science and technology to work for the consumer. Remove these factors, and science will not flourish. Technology can produce great weapons, but it will not bring prosperity without a legal and social system that rewards risky innovation with wealth.

The Communists got cause and effect mixed up. Marx taught that morality is merely the product of the mode of production. He promised the advent of a new man to any society that socialized the economy. What Marxism actually delivered was an oligarchy of old men with bladder problems and nuclear weapons.

Unfortunately, the elite who make decisions in the United States also tend to get cause and effect mixed up, though not so badly as the Marxists did.

SPUTNIK

When I was a junior in high school, the Soviets launched Sputnik: October, 1957. I remember it well because I saw it. Well, not the actual satellite, but the second-stage rocket that launched it. It was circling the globe. The whole country was watching that afternoon. I lived at the beach in southern California. It came over just after sunset. That was perfect for viewing. The sun did not interfere with our line of sight out across the Pacific. Its rays would soon reflect off the rocket, high overhead. We stood in front of the record store where I worked in the afternoon and evening. We looked west. Then we saw a bright light coming up over the horizon. We watched it as it soared in an arc above us and then disappeared over the eastern horizon.

Within days, Congress was debating on how much money to put into education, and whether to limit the subsidy to science. No one was arguing that the federal government had already extended its tentacles around higher education. No one was worried about the bureaucratic red tape that is always attached to green pieces of paper with Presidents’ pictures on them. The Ruskies had beaten us into space, and now there was only one thing to do about it: throw money at the problem.

Public education’s performance peaked over the next six years. But by the time that all that federal money was flowing, test scores had started down. The SAT scores peaked in 1963. Nothing has reversed this trend. American high school graduates perform poorly at math and science — worse than any other industrialized country. Today, over half of the university graduate students in science and engineering are foreign-born.

Yet the United States raced ahead of the Soviet Union in most categories of science and technology. The Soviet Union collapsed economically in the late 1980s and ceased to exist in 1991. All of the money the Soviet government poured into scientific education did not save it from defeat.

If there is a lesson to be learned here it is that government subsidies failed. In education, government money was counter-productive. The U.S. government justified the expenditures in terms of beating the Russians in science, and what it got was poorly trained sociology majors. The Soviets justified the expenditures in terms of world conquest through military power, and went broke trying.

What was missing in the Soviet Union was freedom. Its people had technical skills, but they had little incentive to invent, develop, refine, manufacture, and make a profit from science and technology. The USSR was dependent on imported science and technology from 1917 until 1991. Even the ball bearings used in its MIRVed missiles — multiple warheads per rocket — was imported from a small firm in New England. The late Antony Sutton wrote a multi-volume history, Western Technology and Soviet Economic Development, which proved how dependent the Soviets were on the West. The academic community ignored his work.

The defense industry in the United States still hires thousands of science and engineering graduates. Instead of going into private industry to produce consumer-satisfying demand, they develop weapons systems. Peter Drucker has estimated that any nation that spends more than about 2% of its annual output on the military in peacetime is undermining its private sector. The United States has spent more than this for decades.

Japan and China do not face such pressures. Their graduates go into the private sector. Their capital builds up private companies that compete with American companies for consumer loyalty.

CHINA

Across the Pacific, China is graduating almost 500,000 people a year with college degrees in science and engineering. In a Business Week article published in 2002, we learn of the immense inflow of capital from outside China. This money is not going only to companies that produce goods for Wal-Mart. It includes science and technology.

Taiwan figures prominently in Beijing’s tech strategy. Although the island’s government remains at odds with Beijing’s leaders, Taiwanese businesses have invested about $70 billion in China, and more of those investments are going toward big-ticket items such as semiconductor plants. In September, Taiwan Semiconductor Manufacturing Co. announced plans to invest $900 million in its first China fab. The Chinese market “may take off pretty rapidly,” says TSMC Chairman Morris Chang. In addition, Taiwan’s chip execs are now managing several contract-manufacturing plants in the Shanghai area. . . .

With support from Beijing, ethnic Chinese from around the world are following in the footsteps of Taiwanese and forging new links to China. Shoucheng Zhang, 39, holds joint professorships in the physics departments at Stanford and at Beijing’s Tsinghua University. The latter post was funded by Hong Kong billionaire Li Ka-shing, who aims to entice more overseas Chinese scientists to spend time on the mainland. . . .

In short, Beijing is learning to harness Chinese intellect outside its borders and turn it into a competitive advantage. This has already contributed to strides in technical fields such as superconductivity, nanotechnology, and optics. Says Zhang: “China has been investing very wisely in the sciences. They are doing the right thing.” And while no one has attempted to measure the overseas brain trust China could tap, it is clearly sizable, says Juan Enriquez-Cabot, director of the Life Science Project at Harvard Business School: “When you go into laboratories throughout the world, some of the brightest people are Chinese.” Among the foreign-born scientists and engineers working in the U.S., nearly 40,000 hail from China, more than from any other country.

The flow of capital is now becoming a flood. But if this is true, then China should be experiencing a negative balance of payments. A country that has a positive balance of trade — more goods exported than imported — has to be investing money abroad. But if China is importing more money in the form of capital than it is lending or investing abroad, then it has be experiencing an “unfavorable” balance of trade.

One of the arguments in favor of the U.S. balance of payments deficit of $500 billion a year is this: “America is the best place to invest money. Asian capital is flowing here.” This sounds plausible until you look more closely. It turns out that Asian central banks are buying T-bills by the billions. This money is going down the federal rathole.

Now comes news that has not been publicized in the U.S. China ran a negative balance of payments in the first quarter of this year. This has not happened in 17 years.

The People’s Daily (April 21) reported:

China recently announced a trade deficit of 8.4 billion yuan for the first quarter of this year, the first quarterly unfavorable balance of trade registered by the country in 17 years.

In simple terms, economists explain that a country with a favorable balance of trade is lending money for others, while one with an unfavorable balance of trade is borrowing money.

Is this good for China? The paper quotes an economist who says that it is. He also says that a trade surplus is good.

Dr. Ma Xiaye, president of the Shanghai Academy for World Watch, said that traditionally, a favorable balance of trade is encouraging and desirable as it means money-earning, while an unfavorable balance of trade is also advisable as it means using borrowed money for the nation’s economic development.

Ma quoted as an example that the long-term trade deficit of the United States helps the country keep up its economic development with the support of capital from worldwide.

It would seem that Dr. Ma is a graduate of the Institute of Advanced Studies at Ferengi University. You may recall the two main principles of Ferengi policy: “War is good for business.” “Peace is good for business.”

A trade deficit of 8.4 billion dollars is a trifle in the context of the total imports and exports of 239.8 billion dollars conducted by China during the first quarter of this year, Ma noted.

Investment in China is rising fast. This is a risk to anyone who does not have family ties in China. The legal system in China is neither Western nor capitalist. The currency exchange rate is set by the government, not the free market. Getting your money out of China is likely to be a problem. Then there is the problem of massive monetary expansion by the Chinese central bank. This is creating a bubble economy. Bubbles eventually pop.

But the fact that so much money is flowing into China today indicates that the West is fast viewing China as a source of more than low-technology goods. Western investors are looking at a pool of highly educated scientific talent. If investors can harness this talent in consumer-satisfying ways, then China is going to become a fierce competitor in international markets for mid-tech and eventually high-tech products.

THE DEAD HAND OF REGULATION

In his April 22 column, Thomas Friedman, the generally leftist columnist of the New York Times, admitted in print that the United States’ economy has a major problem: a more favorable business climate in China than here. He visited executives in California’s silicon valley.

Several executives explained to me that they were opening new plants in Asia — not because of cheaper labor. Labor is a small component now in an automated high-tech manufacturing plant. It is because governments in these countries are so eager for employment and the transfer of technology to their young populations that they are offering huge tax holidays for U.S. manufacturers who will set up shop. Because most of these countries also offer some form of national health insurance, U.S. companies shed that huge open liability as well.

Can you imagine this? Here are a bunch of commies who are offering sweetheart tax breaks to Western companies. Low taxes benefit business. Aren’t commies supposed to be anti-business? I mean, what kind of crummy Marxism is this?

Other executives complained bitterly that the Department of Homeland Security is making it so hard for legitimate foreigners to get visas to study or work in America that many have given up the age-old dream of coming here. Instead, they are studying in England and other Western European nations, and even China. This is leading to a twofold disaster.

First, one of America’s greatest assets — its ability to skim the cream off the first-round intellectual draft choices from around the world and bring them to our shores to innovate — will be diminished, and that in turn will shrink our talent pool. And second, we could lose a whole generation of foreigners who would normally come here to study, and then would take American ideas and American relationships back home. In a decade we will feel that loss in America’s standing around the world.

Still others pointed out that the percentage of Americans graduating with bachelor’s degrees in science and engineering is less than half of the comparable percentage in China and Japan, and that U.S. government investments are flagging in basic research in physics, chemistry and engineering. Anyone who thinks that all the Indian and Chinese techies are doing is answering call-center phones or solving tech problems for Dell customers is sadly mistaken. U.S. firms are moving serious research and development to India and China.

Friedman concludes: “We have got to get our focus back in balance, not to mention our budget. We can’t wage war on income taxes and terrorism and a war for innovation at the same time.” Call this “the education of Thomas Friedman.” Who knows? Maybe this perspective will actually have some influence on the editorial page of the New York Times. But don’t bet your pension money on this possibility.

This problem is not going to go away. It is going to get worse.

Craig Barrett, the C.E.O. of Intel, noted that Intel sponsors an international science competition every year. This year it attracted some 50,000 American high school kids. “I was in China 10 days ago,” Mr. Barrett said, “and I asked them how many kids in China participated in the local science fairs that feed into the national fair [and ultimately the Intel finals]. They told me six million kids.”

Got that? We are facing a rising tide of skilled workers whose talents will go into meeting consumer demand. This is great news for productive workers around the world who will produce products that the Chinese want to buy. This is bad news for workers who have degrees in sociology.

For now, the U.S. still excels at teaching science and engineering at the graduate level, and also in university research. But as the Chinese get more feeder stock coming up through their high schools and colleges, “they will get to the same level as us after a decade,” Mr. Barrett said. “We are not graduating the volume, we do not have a lock on the infrastructure, we do not have a lock on the new ideas, and we are either flat-lining, or in real dollars cutting back, our investments in physical science.”

CONCLUSION

The idea of free market competition has spread to China. This is what my generation, and the generations before mine, said we hoped would happen. That the Protestant work ethic is also Confucian makes this transfer of ideology possible. Marxism hampered anything like this from happening. Anti-Communists wanted to see China’s masses abandon Marxism. To the extent that the Chinese masses ever adopted Marxism, this has now taken place.

There is a price to be paid here. An army of highly competitive people is being assembled in China. The question now is this: Will these people suffer the fate of all those bright science students in the Soviet Union? Will their talents be squandered in fruitless service to a bureaucratic State? The answer so far seems to be “no.”

Character and commitment count for more than technical education. Opportunities to serve others through voluntary exchange is more important than mathematical skill. A social, legal, and economic system that allows creative people to get very rich if they satisfy consumer demand counts for more than graduate schools in engineering.

The problems we face are mostly home-grown. America has had these competitive advantages for over a century. But, year by year, our governments at all levels tighten the screws. Congress passes new laws. Bush signs all of them. The Federal Register prints over 70,000 pages of new regulations each year.

From the looks of things, the entrepreneurial spirit is alive and well in China. The government is steadily pulling out of the economy. A recession/depression may reverse this pull-out, but that is not clear at this point.

Economic growth takes place when politicians and bureaucrats pull out of the economy. We are seeing a great reversal. The Communists are pulling out, and Western governments keep adding to the maze of regulations. Meanwhile, Asians are good at math and science. If it turns out that they are innately gifted with entrepreneurial skills, which the reversal of Marxism sets free, then the flow of capital to China will accompany the flow of goods out of China.

Then who will buy T-bills? At what interest rate?

May 1, 2004

Gary North [send him mail] is the author of Mises on Money. Visit http://www.freebooks.com. For a free subscription to Gary North’s newsletter on gold, click here.