A Keystone for Economic Statecraft

Editor’s note: This is the ninth article in an 11-part series examining how the United States should organize, lead, and integrate economic statecraft into strategy, defense practice, and the broader national security ecosystem. The special series is brought to you by the Potomac Institute for Policy Studies and War on the Rocks. Prior installments can be found at the War by Other Ledgers page.

In September 2010, after a Chinese fishing trawler captain was detained near the Senkaku Islands, Beijing halted rare-earth exports to Japan. The embargo lasted weeks. China showed, on a U.S. treaty ally, how a supply chain could be weaponized. Washington failed to respond. Nor did America generalize the lesson. Instead, it benefited from deflation as it increased its dependency on China over the past 20 years. The number of Chinese companies exporting into the U.S. manufacturing supply chain rose from 10,500 to 39,000 from 2005 to 2024.

China’s rare earths actions are just the tip of the spear — the shaft is now coming through the bulwarks. High quality Chinese vehicles, unimaginable in Western markets a decade ago, are displacing incumbents across Europe, Latin America, and Southeast Asia. Canada, America’s largest trading partner, is considering Build Your Dreams (BYD) assembly plants on its own soil. Chinese firms hold ownership stakes in roughly 10,000 U.S. auto-parts suppliers. China’s share of global manufacturing exports climbed from 5 percent in 2000 to 20 percent in 2023, while America’s fell from 14 to 8 percent during that time. Not even COVID-19, which should have been a wakeup call, stirred America to address its own dependencies. Put succinctly by Craig Tindale, an investment manager, “A country that cannot make, refine, power, move, and repair the physical systems it depends on can be remote controlled by a country that can.”

The case for action is not only strategic. Manufacturing is among the most economically stimulative sectors in the U.S. economy: Every dollar of manufacturing output generates  $2.69 in total economic activity, and every direct manufacturing job supports roughly five others, with every dollar of manufacturing wages generating $4.33 in total labor income. Advanced manufacturing, robotics, and AI will widen those ratios as well as increase productivity. China’s industrial productivity gains have tracked closely with its robotics adoption, which far exceeds that of America’s. This makes growing the manufacturing base  more important, not less, to sustain high employment and GDP.

The U.S. government has already made a few moves to address the challenge, including the One Big Beautiful Bill of 2025, the Office of Strategic Capital’s $200 billion authority, and the rare-earth and Pax Silica initiatives. While necessary to boost the defense industrial base, these actions do not reach the broader commercial and industrial base or the “missing middle”: the hundreds of thousands of manufacturers and dual-use suppliers that are the heart of America’s production base.

Here, I endeavor to make the case for revitalizing American manufacturing by explaining why economic statecraft fails without commercial manufacturing competitiveness; how, unlike software and services, manufacturing delivers low profitability, is starved for capital, and offers thin entrepreneurial rewards; which free-market levers could make America more competitive; and finally, what Congress should do, and when. It took 30 years for the United States to lose manufacturing. Rebuilding it will not be fast, easy, or free.

Economic Statecraft Requires Near-Competitive Products

Economic statecraft involves offering superior products to allies at near-competitive prices, setting technical standards, building supply chain dependencies that create leverage, and threatening to withhold what you can provide credibly.

As the United States outsourced manufacturing in recent decades, it benefited from importing deflation. Yet, at the same time, it lost foundational capabilities in shipbuilding, rare-earths processing, and producing pharmaceuticals, semiconductors, drones, robots, and batteries, among other products. This has put a significant drain on GDP. Meanwhile, according to the Rhodium Group, an independent research firm:

China’s industrial policy is becoming more systemic and pervasive, extending across all layers of production from upstream inputs and industrial equipment to downstream applications, services, and frontier technologies … Beijing also increasingly deploys policy tools to entrench its dominant position in global value chains and counter foreign diversification strategies.

With 330 million people, versus China’s 1.4 billion, the United States acting alone loses on scale. Instead, it needs the collective volume of its traditional allies and partners. With a total population of 2.7 billion and combined GDP of $34 trillion, Europe, Japan, South Korea, India, Australia, and much of Southeast Asia have the capital, technology, and market depth to compete with China. The math works, but only if American manufacturing can deliver on feature, function, scale, and price. Pivoting from a blunt tariff-centric approach to a tariff- and coalition-building one may be the glaring opportunity that U.S. leaders can soon (re)embrace.

Under the second Trump administration, a renewed strategic focus on the Western hemisphere shows progress with receding Chinese influence in Central and South America, including Panama, Peru, and Chile. However, as the United States reasserts itself, trade is needed to back it up. Over the last 25 years, Chinese trade in the region has grown from virtually nothing to half a trillion dollars a year. Already by 2015, Beijing was the top trading partner for most of South America. Since then, it has become an even more significant economic player. Chinese exports of consumer goods, high-end electronics, and cars undercut U.S.-made products, while its outsized demand for commodities has drawn the region further into its orbit. Recapturing these markets requires competitive products.

Wealthy and Impotent

America is caught in a trap. Despite an immense debt load, the U.S. economy remains the envy of the world: GDP growth leads the G7 and unemployment is near historic lows. The world’s deepest capital markets, the world’s reserve currency, and, historically, the strongest alliance network in history, undergird America’s military and deficit spending. Unresolved is the balance of cost and benefits accruing to the reserve currency holder. However that argument resolves, a competitive manufacturing base is required to practice economic statecraft effectively. For example, the United States and Canada have long co-built automobiles. As Canada — America’s second-largest trading partner — considers building Chinese BYD car factories at home, the message is clear: China’s manufacturing depth, rapid product cycles, and leading battery technology deliver inexpensive, feature-rich cars. Were Canada to strongly embrace Chinese vehicles, its trading relationship with America could fracture.

Ford is responding and expects to deliver a Tesla-competitive car in mid-2027 at BYD-level manufacturing costs. Ford’s actions will roll through its supplier base, spurring upstream reshoring, reinvestment, and revival. Such investments should be replicated widely.

Capital without manufacturing becomes financial extraction, not strategic investment. S&P 500 companies returned over $12 trillion to shareholders through buybacks and dividends between 2015 and 2024 — capital that did not build factories. Innovation without production becomes a gift to competitors. The United States invents while China manufactures. Yet, America’s import dependence — offshoring manufacturing on the promise of higher profits via lower manufacturing costs in China — gave Beijing the opportunity to scale as it innovated, copied, or stole capabilities.

Leveraging America’s Strengths

America’s institutional advantages are as real as its capital advantages. The United States combines an unusually high tolerance for entrepreneurial failure, a globally dominant startup ecosystem, deep public-private research capacity, and a venture-capital-centered financial architecture that rapidly flows capital to new ideas. However, without competitive manufacturing, capabilities, skills, and capacity atrophy. A country, or Congress, unable to finance manufacturing companies through the so-called valley of death from prototype to scale production or rebuilding capacity with software-led advanced capabilities.

Rebuilding the missing middle would strengthen every dimension of U.S. economic statecraft, deepening the production base that makes leverage real, reducing the import dependencies that adversaries exploit, and restoring the manufacturing credibility that makes the allied coalition offer credible.

The choice America faces is either rebuilding critical domestic manufacturing or continued dependence on China. Currently, 70,000 American manufacturing companies import from 45,000 Chinese suppliers (notably, the 45,000 companies themselves buy from other Chinese manufacturers). Rebuilding imputes a necessary choice: manufacturing output with automation-augmented jobs, a Rubicon China crossed years ago. As a result, Chinese workers produce considerably more physical output per worker than do Americans — that lead compounds.

Japan has eagerly adopted robots to improve productivity and offset a decline in its working population. It has about 70 percent of the global market for robots. In the 1980s, America adopted lean manufacturing, Japanese management, and production technologies. Incentivized with capital and talent, America’s entrepreneurs will be eager to learn from Japan and any other company or country.

One source of knowledge and experience will come from integrating defense manufacturing knowledge into commercial manufacturing, including in software, robotics, and AI augmentation. Defense firms including Hadrian, Anduril, and Divergent are leading the way, while Tesla is doing so in the non-defense sector. Green shoots — in the form of software, AI, marketplaces, and robot companies — are beginning to appear.

Robotics adoption should not be mandated or directed by government fiat. Instead, monetary incentives can help the free market rebuild domestic manufacturing.

A revitalized manufacturing sector with workers overseeing AI-optimized factory floors is how America leapfrogs its lost industrial base — and it’s a big leap. The scope — likely hundreds of thousands of companies — is too large for government programs to pick winners. The incentives should be free-market oriented and directed towards increasing domestic manufacturing value. Free-market means available to any manufacturing company, meeting some set of requirements, not going through a lengthy government application process, and not a function of personal or political connections.

What To Do

The free market is America’s superpower. It’s time to release it in three ways to rebuild domestic manufacturing. First, improving income statements through transferable tax credits scaled to the percentage of domestic value added which directly improves profitability. Second, making credit more available via Mannie-Mac, bank-delivered low-cost manufacturing loans, funding expansion, investment, and improving profitability through a lower cost-of-capital. Third, increasing rewards for entrepreneurs via a qualified small business stock-style exemption, designed for founders and leaders running and growing manufacturing firms, rewarding operators, not investors, for building manufacturing companies.

Improving Income Statements

It is no surprise that capital has fled manufacturing — it returns less money than other sectors. The result is a self-reinforcing cycle of low profitability, underinvestment, and capability attrition and outsourcing.

New York University Professor Aswath Damodaran provides the most comprehensive public data and analysis for corporate comparisons. Against broad manufacturing in the United States, software, business services, and consumer services companies earn about 1.8 times the return on capital. Against more narrowly focused capital-intensive sectors, the multiples are far starker, with software approximately 6 times more, services nearly 5.7 times more, and pharmaceuticals about 3.4 times more.

Transferable tax credits, scaled to the percentage of domestic value added, can deliver direct income statement support to established, middle market, and start-up companies as they invest in new facilities, equipment, products, people, and markets. Improved profitability improves return on investment, attracting capital and talent.

Increasing Capital Availability

Beyond profitability, the high cost of capital, when it is available, compounds the low return problem. U.S. small-to-midsize manufacturing firms borrow at 7 to 11 percent more than in China. Small Business Administration loans, limited to five million dollars, charge 10 to 12 percent.

Independent of the cost of capital, the United States banking system does not finance domestic manufacturing at the scale or terms that a reshoring agenda requires. The competitive disadvantage for U.S. manufacturers is a profitability, capital cost, and capital availability problem that tax policy alone (including the One Big Beautiful Bill) does not solve. Scaling production requires more money.

Mannie Mac, low-cost capital delivered by banks directly to companies, gets both the government out of winner-picking and companies out of multi-year application processes. Like Fannie Mae and Freddie Mac, which drove home ownership, Mannie Mac can support mid-size companies in investing in advanced manufacturing to gain capacity, scale, and price.

Rewarding Entrepreneurs

Entrepreneurialism is another American superpower. Entrepreneurs and their employees take risks joining small companies, investing their time and sometimes capital in exchange for equity with the expectation of larger returns. However, since manufacturing companies generally return less money than software and services companies attracting talent to manufacturing requires the promise of additional returns.

The current applicable program, the qualified small business stock, rewards investors and employees with capital gains tax exemption, with strict $15 million limits per person or 10 times the share cost basis —whichever is greater. However, the program applies only to C corporations, while many start-ups, family businesses, and existing manufacturing companies are S corporations or limited liability companies.

The most direct free-market reward for entrepreneurs is money. Whether a founder buys an existing manufacturing business or starts a new one, increasing the monetary reward via a manufacturing-only capital gains tax exemption tilts the entrepreneurial calculus where it is needed. A significant capital gains exemption program, up to $250 million, across operational equity holders can support manufacturing company transitions from baby boomers to their children, and founders and management starting and running manufacturing companies.

More than 100,000 manufacturing companies are expected to undergo ownership transition over the next decade as baby boomer founders retire. Without intervention, these companies face private equity acquisition for asset extraction, sale to foreign buyers, and closure.

Talent follows capital, and capital follows returns.

Conclusion

Manufacturing competitiveness is the precondition for every other instrument of American power.

A country cannot practice economic statecraft effectively without competitive products to offer, withhold, and build upon. The military cannot defend the country without the industrial base to produce what defense requires at price and scale. The United States will not lead the technological future without the physical infrastructure to manufacture it, and America cannot make the allied coalition math work without a credible economic offer that closes the gap.

Solving for manufacturing means solving for relative profitability and returns, supplying low-cost capital for scale, innovation, and reshoring, and rewarding entrepreneurs for founding and running manufacturing companies. This takes U.S. government leadership and action. It will not happen by itself.

America is wealthy in the assets that matter — capital, talent, alliances, and innovation — and increasingly unable to deploy them because those assets lack physical expression. With every quarter that the manufacturing base continues to hollow out, the gap between America’s potential and its deployable statecraft capacity widens.

America’s superpower remains the free market, which responds to incentives. If America wants a different outcome, incentives should be changed — it cannot “winner-pick” its way to success. Government policy should not pick winners and must address upstream and downstream supply chains. Targeted industrial policy risks stranding isolated capacity, and current efforts on rare earths and semiconductors carry this risk. China has been building deep supply chains, while America has been losing them.

The investment required to compete is a fraction of the cost of the alternative — an America that cannot produce what its statecraft requires.

 

Mark Rosenblatt runs Rationalwave Capital Partners, an early-stage venture fund. He has analyzed, founded, ran, sold, and invested in technology companies for 45 years.

Image: Maurizio Pesce via Wikimedia Commons.

Source link