There is no mistaking the fact that the United States is in intense economic competition with the People’s Republic of China (PRC). The shape this competition takes depends critically on the policies pursued by the second Trump administration over the next four years, with plenty of scope for valuable lessons from the last four years.
Like the first Trump administration before it, the Biden administration imposed large tariffs on China, and both administrations did so in no small part to support domestic manufacturing. And in the first two weeks of the second Trump administration, even more tariffs have been placed on goods imported from the PRC.
While, in his first term, President Trump lamented the bilateral trade deficit and touted the Phase One agreement that was supposed to rectify it (narrator: it didn’t), the Biden administration focused on critical dependencies in supply chains, such as semiconductors, electric vehicle batteries, and the minerals that go into both. What is missing from both strategies for competing with China is a focus on what is too often the unsung driver of U.S. competitiveness: services.
Overall, services represent about 75 percent of the U.S. economy, and the United States dominates the global market for tradable services. The tradable services sector, including finance, legal services, healthcare, and high-tech services, employs more Americans than all of manufacturing combined. Services trade accounted for $7.9 trillion of global exports in 2023, and the United States accounted for $1 trillion of that total, with a nearly $300 billion trade surplus. In 2023, the PRC had a net trade deficit in services of over $150 billion. And as has been pointed out by Richard Baldwin and others, while merchandise goods trade has stagnated as a share of global GDP since the Great Recession, services trade has not. And the United States remains one of the fastest-growing service exporters among developed countries. At the same time, my own research has shown that some of the largest, most globally integrated U.S. firms have been repurposing their existing manufacturing establishments to produce tradable services.
The tradeable service sector is not only critically important to the U.S. economy because of its size, but also its productivity growth. Virtually all U.S. productivity growth over the last decade has come from services, with tradeable service industries playing an outsized role. At the same time, U.S. manufacturing productivity has been stalled for the past 15 years. And despite massive investments from both the government and the private sector over the last four years, manufacturing total factor productivity fell during the Biden administration. There is obviously no one way to adjudicate who is winning the economic competition between the United States and the PRC, but there is no doubt that economic growth is at the heart of the race. Without the growth of services, the United States would be treading water.
One might argue that, even though these sectors contribute a significant portion of our national income and drive growth, they are still less important for economic security because that is determined by our ability to produce physical things (i.e., manufacturing). Even if this were one’s argument, tradable services still play a critical role in this aspect of the economy. By the best available estimates, more than 30 percent of the value of goods exports is embedded tradeable services (e.g., everything from the software in your car or smartwatch to the logistics services that manage supply chains). As a result, innovations in U.S. services industries indirectly aid U.S. manufacturing competitiveness.
Additionally, there is a growing body of evidence that shows that high-tech tradable services, such as AI-enabled software, can directly increase manufacturing productivity. While we are still waiting for AI to produce aggregate productivity gains, an excellent new research paper by Aidan Toner-Rodgers documents the impressive productivity gains achieved using AI to improve the discovery rate of new compounds in material sciences. Toner-Rodgers shows that AI-enabled researchers discovered 44 percent more materials, resulting in 39 percent more patenting, and a 17 percent increase in product innovation. If gains a fraction of this size can be replicated in other industries, it would have massive implications for U.S. manufacturing productivity and as a result, would play a critical role in our economic competition with the PRC.
High-tech services are critical to the current shape of our competition with the PRC, but it is important to remember that our current strength in these industries is a product of the wise investments the United States made in the past. The U.S. education system, immigration policy, regulatory regimes, investments in digital infrastructure, and favorable investment climate all laid the groundwork for our current competitive advantage in these industries.
A highly skilled, highly educated workforce has long been an important driver of U.S. innovation and a source of comparative advantage in high-tech industries. As a result of the G.I. Bill, the Elementary and Secondary Education Act, the National Defense Education Act, and many other critical investments in education, the United States has long had one of the most educated populations in the world, but other countries, including China, are catching up fast. In China, the average years of schooling for those of prime working age has doubled over the last 30 years. For the United States, this same metric has fallen, and in 2024, U.S. children’s reading scores hit new lows. Rather than eliminating the Department of Education, as Trump has suggested, the administration should consider expanding federal funding for primary and secondary education and increase funding for basic research through universities and national labs.
Throughout U.S. history, immigration has also been an indispensable source of talent that has driven U.S. innovation. In the absence of comprehensive immigration reform, available skill-based visas have not kept up with demand, resulting in less research and development (R&D) being conducted in the United States. Research by Britta Glennon demonstrates that when U.S. firms are constrained by a lack of access to H1-B visas, they relocate their R&D to Canada, where they can more easily hire talent. By expanding the number of skill-based visas, issued and allowing workers to stay in the country after finishing training visas (such as J-visas), the United States can attract more talent and encourage more innovation.
The U.S. innovation ecosystem has also been fostered by its regulatory environment that allowed entrepreneurs to start companies in their garage, with many of those companies going on to be some of the largest, most profitable, and most innovative firms in the world. However, the competitive environment that existed in the 1980s is not the same as we have today. Over the last 40 years, the rate at which new high-tech firms are created has nearly halved. With half as many new startups, the United States could risk having half as many unicorns in the years and decades to come. Increasing regulatory alignment with allies and partners, reducing domestic regulatory barriers to entry, keeping costs down by avoiding unnecessary tariffs on inputs, and expanding access to credit for entrepreneurs would all benefit high-tech services industries and the economy overall.
The production and use of intangible services, which are embedded in every aspect of our lives, is a critical front in the economic competition between the United States and China. Like other fronts, neither side is assured of success, and the policies that we pursue in the coming years will play a critical role in how it unfolds. To the extent to which the United States currently enjoys a lead, that advantage has been built on decades worth of smart policies. If we want this success to continue, we need to prioritize the same type of market-friendly, pro-talent, pro-innovation policies over the next four years and beyond. Equally important is that the United States avoid, when possible, policies that hinder innovation within the service sector. Tariffs, export controls, investment screening, and research security policies may be important to protect certain industries and aspects of our national security, but they also come at a cost. Many of these costs may seem small at the moment, but just like the benefits of wise policies compound over time, so too do the penalties of unrealized innovation. And at the end of the day, innovation will play a decisive role in determining the winner of this economic competition.