America Must Rebuild Its Physical Economy
In order to compete with China and boost growth, the United States must better balance the software and hardware components of its economy.
Throughout most of the twentieth century, the United States stood as the world’s premier industrial force. The country’s manufacturing prowess helped it shift the tide in two world wars and cement its position as a global superpower. Over the past fifty years, however, the United States has allowed much of its industrial capacity to lapse. Spurred by liberalizing economic reforms and accelerated by the end of the Cold War, U.S. companies offshored manufacturing to regions with cheaper labor, lighter regulations, and more accommodating governments.
This deindustrialization is by now a well-worn narrative, its physical and psychological scars clearly visible across the American heartland and modern political discourse. Only in recent years have U.S. policymakers begun to grapple with the economic and national security ramifications of this transformation. The software- and finance-driven economy that arose in the wake of America’s industrial retreat has generated astonishing amounts of wealth and put the United States at the forefront of emerging technologies like artificial intelligence.
However, the hollowing out of U.S. manufacturing has also left the country lagging behind in producing hardware-oriented areas of technology like electric vehicles (EVs), consumer drones, batteries, and robotics. Furthermore, offshoring has weakened the U.S. defense industrial base, which many experts fear cannot currently meet wartime demands for materiel.
Meanwhile, the United States’ greatest geopolitical competitor, China, has built up its manufacturing capacity and has taken a more diversified and strategic approach to technological development. As a result, China has come to dominate the global market for many areas of hardware in which the United States has fallen behind. Furthermore, Beijing has used targeted policies to stand up a globally competitive software ecosystem, one that today poses a serious challenge to leading U.S. firms.
In the years ahead, military primacy and economic growth may hinge on the integration of software and hardware across a range of applications. While still in their early stages of development, AI-powered drones are changing how wars are fought, increasingly autonomous EVs are ever more prevalent in the global economy, and robots are already disrupting manufacturing processes in Europe and Asia. Given its software and hardware capabilities, China is better positioned than the United States to capitalize on such synergies, potentially threatening U.S. economic and national security.
In order to compete with China and boost growth, the United States must better balance the software and hardware components of its economy. This will require Washington to rebuild America’s “physical economy”—the infrastructure and technical know-how to produce tangible goods. President Trump’s ongoing tariff plan is intended to galvanize this economic realignment. While this strategy could ultimately reshore some manufacturing capacity, it may backfire if the administration continues to alienate U.S. allies. In the years ahead, it will be critical to coordinate with global trading partners, as well as re-skill the domestic workforce, to expand production of the emerging technologies that will power tomorrow’s economies and supercharge defense.
Going All in on Software
Decades ago, as heavy industry retreated overseas, U.S. leaders turned to financial services and software to fuel the country’s economic engine. The rollback of regulatory guardrails led to boom times on Wall Street, and decades of federal investment helped lay the foundation for a vibrant software ecosystem in Silicon Valley, which was well-positioned to exploit the growth of the public internet and the personal computer revolution.
In many ways, computer software was the ideal technology for the shareholder-friendly brand of capitalism that has defined the U.S. economy for more than four decades. Unlike hardware products, which often require expensive facilities, specialized equipment, and lots of energy to build, software products need relatively little upfront capital. Once developed, these tools can be reproduced and scaled at very low cost, and downloaded instantly all over the world. All of this makes software development a high-margin enterprise, one that is immensely attractive to investors looking to maximize their ROI.
The relentless pursuit of returns and market share led us to our present moment, in which nearly half of the U.S. stock market’s value is wrapped up in technology and financial services. While U.S. tech leadership was once defined by companies that built physical products, like General Electric, AT&T, and IBM, today it is defined by companies that code digital ones, such as Google, Microsoft, and Meta. Silicon Valley still boasts several leading “hardware” companies, including Apple and Nvidia, but these firms largely depend on foreign suppliers to manufacture their products.
This decades-long march “up the value chain”—away from domestic manufacturing and toward software and financial services—has created a situation in which the United States designs and programs many of the world’s most advanced technologies, but relies on countries like China to build them. While this global division of labor may have made sense to U.S. policymakers in the immediate aftermath of the Cold War, when U.S. hegemony went unchallenged and great power conflict seemed a relic of the past, it is not well-suited to the present moment of geopolitical tension. Military dominance may increasingly hinge on the mass production of dual-use technologies like drones. In such a world, China, with its more diversified—and in many ways more capable—industrial base, could pose a major challenge to U.S. economic and military preeminence.
The World’s Factory
As the United States turned to software and finance to power its economic engine, China dedicated itself to becoming a manufacturing powerhouse. After the Chinese economy began to liberalize in the post-Mao years, state support coupled with affordable labor and economies of scale propelled Beijing to become the preeminent producer of global goods. China is now the world’s factory, responsible for around one-third of global manufacturing output, roughly three times the share of the United States in terms of gross production.
Many experts expected China to move away from manufacturing toward software and finance as its economy developed, just as the United States and others had done in the past. But Beijing has instead doubled down on its production-first strategy. Rather than offshoring its manufacturing capacity elsewhere, Beijing implemented industrial policies like Made in China 2025, pushing companies to move from making lower-value goods to more complex and profitable products.
In its drive to dominate advanced manufacturing, China has fostered an interconnected ecosystem of globally competitive technology companies while maintaining the infrastructure, supply chains, and technical expertise necessary to build its products. Continuing to cultivate this domestic industrial know-how has enabled companies across sectors to refine manufacturing techniques, make products more efficiently, and leverage one another’s innovations to make more sophisticated goods.
While this industrial strategy has contributed to trade frictions, economic imbalances, and domestic price wars, it has also helped Chinese companies dominate the global market for critical technologies, many of which can be applied in both civilian and military contexts. Today, Chinese-made EVs constitute up to 76 percent of global sales. Shenzhen-based DJI controls around 90 percent of the consumer drone market, and its products have been used on both sides of the Ukraine–Russia conflict. China also dominates advanced manufacturing, and it installs nearly as many industrial robots each year as the total number currently in use across the United States.
At the same time, several Chinese companies have also emerged as top players in the international software sector. Huawei is making inroads in the global mobile market with its Harmony OS, an operating system developed in part to reduce the company’s over-dependence on Google and Apple. TikTok is now one of the world’s most popular social media platforms, its U.S. legal situation notwithstanding. Most recently, DeepSeek emerged as a legitimate challenger to U.S. AI developers due to the performance and popularity of its affordable, open-source models.
However, even as the Chinese software ecosystem has matured, Xi Jinping has ensured the industry does not come to dominate too much of the Chinese economy. Concerned about the growing influence of China’s big technology companies, as well as the risks of growing wealth inequality due to financialization and digitalization, a few years ago, Xi embarked on a regulatory crackdown aimed at limiting the economic reach and political power of prominent firms like Alibaba and Tencent. While this pressure has lightened in recent years amid the intensifying U.S.-China technology competition, Xi has made it clear that China will continue to shore up its physical economy even as its digital economy matures.
The Risks of the U.S. Approach
In recent years, a series of supply chain disruptions, military conflicts, and intensifying international tensions have exposed the weaknesses of the U.S. approach to technology development and underscored the strengths of the Chinese model. In order to project power in the twenty-first century, nations must be able to design, produce, and deploy both hardware and software at scale. While China has invested in both, the United States has over-indexed on the latter. As a result, the United States could find itself at a distinct disadvantage in economic and military competition in the decades ahead.
The United States currently struggles to compete in most categories of hardware that show a high potential for future growth. U.S. firms find it difficult to produce electric vehicles, robots, consumer drones, and advanced batteries at the scale and price that would make them competitive with Chinese companies. While it may be possible for the United States to compete with China in these sectors, establishing the necessary production capacity requires significant, if not unattainable, investments of time, money, and political will. Such efforts would also need to be targeted toward particular emerging industries, a departure from the sprawling trade restrictions the White House is currently pursuing.
While the United States boasts a robust software ecosystem, any advantages that it maintains over China in this domain may be fragile given the relative ease with which competitors can appropriate new software innovations. Open-source software packages can be downloaded from GitHub, data and code can be stolen by hackers, and U.S. AI models can be co-opted to train Chinese counterparts. Locking down software with cybersecurity measures, export controls, and other mechanisms may slow this diffusion, but motivated actors could find ways to evade these measures. By contrast, advantages in hardware may be more durable—hackers can exfiltrate the blueprints for a widget, but they cannot download the factory that builds it.
Today, U.S. policymakers must grapple with the reality that the United States and China are locked in a close race for software and AI dominance. Still, Beijing holds a substantial advantage in supply chain control and hardware production capacity. By maintaining a more diversified technology ecosystem, China is better positioned to integrate leading hardware with cutting-edge software, creating synergies that could accelerate innovation and deployment of novel technologies.
DeepSeek has already struck deals to integrate its AI into robots and electric vehicles to boost autonomous driving capabilities and deployed it across hospitals and state-owned enterprises. It is unclear whether these partnerships are providing any distinct advantages. Such collaborations may offer Chinese AI companies paths to profitability and growth that are unavailable to their U.S. counterparts, who have fewer domestic hardware firms with whom they can work.
China’s software prowess and hardware dominance could also give it an edge in future military conflicts. As the war in Ukraine has demonstrated, military advantage in the years ahead may lie with countries that can produce the most materiel and aim it with enough accuracy. Both the Ukrainian and Russian militaries are prioritizing the manufacturing and use of thousands of small, affordable drones that, when combined with advanced software, have proven to be deadly new weapons.
There is perhaps no country better equipped to fight these wars of “precise mass” than China. Beijing is investing in swarming algorithms and AI for wartime decision-making, and it already boasts high-level drone and missile capabilities. The same factories that manufacture EVs and robots could easily produce the drones and other supplies needed for a high-intensity conflict. As others have pointed out, China’s redirection of funds from real estate to manufacturing has boosted its defense industrial base.
To be sure, the United States has also started to reorient its arsenals around small, affordable platforms. The Biden administration launched the Replicator Initiative to boost drone production and deployment, the Pentagon is drafting concepts of operations involving massive drone swarms, and members of President Trump’s team have pushed to refocus on small, attritable weapons systems rather than large, expensive platforms like F-35s. Yet, whether the United States can actualize such plans remains an open question.
U.S. defense companies now struggle to produce even conventional military equipment like artillery shells at the scale necessary for wartime. Consolidation in the defense industrial base has made national security supply chains more brittle, and in some cases, the Pentagon relies on China to supply components for critical technologies. While leaders could ramp up domestic manufacturing of military materiel using the Defense Production Act, it would be difficult for the United States to sustain a war against a near-peer adversary like China without rapidly exhausting its supply of small drones, missiles, and munitions.
An Uncertain Path Ahead
As tensions with China have intensified, U.S. policymakers have begun to recognize the risks of offshoring the country’s industrial capacity, pursuing policies to “de-risk” supply chains and re-order the international trade system. But these initiatives pale in comparison to the scale of the problem. Without making significant efforts to boost its productive capacity, the United States could find itself at a severe disadvantage in future economic and military competition.
The need to expand domestic industrial capacity is clear, but the United States has few good options. Yes, some defense startups are building facilities to produce materiel domestically and at scale. And defense primes are focused on manufacturing exquisite military hardware, some of which is necessary but not sufficient to win the next war. As of now, neither startups nor legacy defense companies can match China’s manufacturing heft.
The federal government has a crucial role to play in transforming the U.S. manufacturing base. The United States should not necessarily strive for complete self-sufficiency, but rather work with allies such as Germany, Japan, and South Korea to boost manufacturing capacities that rival those of China. The Trump administration might explore how to exploit industrial complementarities to become more competitive in emerging consumer and military technologies and to redirect and fortify the supply chains on which production relies. The administration could focus its efforts on creating shared industrial standards with allies to foster modular product ecosystems, which could help alleviate manufacturing bottlenecks and reduce barriers to entry for new companies.
Moreover, Washington must invest in machines that make other machines, including industrial robots, 3D printing capabilities, and other advanced manufacturing techniques, areas in which China currently dominates. Whereas countries like South Korea, Germany, and Japan have embraced the trend toward industrial automation, the United States has fallen behind.
While automated manufacturing is unlikely to support as many jobs as traditional twentieth-century factories, new high-tech facilities could still provide novel employment opportunities for U.S. workers. Indeed, for the United States to continue to thrive, the public and private sectors must make major investments in human capital. Federal, state, and local governments can set up Americans for a new industrial age by partnering with companies and educational institutions to foster technological literacy and support reskilling initiatives. By producing a robust talent pipeline that supports emerging jobs in advanced manufacturing, for example, Washington can enhance U.S. competitiveness and security while enabling more Americans to participate in this expanding industry.
Even if Washington can maintain its shrinking software and AI advantages, it might not be enough to win a conflict over Taiwan. Though some question the Chinese military’s combat readiness, it has become a formidable fighting force. To better deter China, the United States must adopt a targeted strategy to boost its hardware manufacturing capabilities. Strengthening the U.S. position in emerging technologies, rather than trying to recapture traditional supply chains, will be critical. To do this, Washington should invest in industrial automation, and the Pentagon should position itself as a reliable purchaser of smaller systems. Government policy must complement U.S. defense startups’ efforts to field a more competitive fighting force for the twenty-first century.
About the Authors:
Sam Bresnick is a Research Fellow at Georgetown’s Center for Security and Emerging Technology (CSET), focused on AI applications and Chinese technology policy. Previously, he was a Senior Research Analyst at Carnegie China, where he researched U.S.-China relations, Chinese foreign policy, and East Asian security and economic issues. Sam’s analysis has been published in Wired, Foreign Policy, and The New Republic, among other outlets.
Jack Corrigan is a Senior Research Analyst at Georgetown’s Center for Security and Emerging Technology (CSET), where he focuses on the U.S. innovation ecosystem and national competitiveness. Previously, Jack collaborated on a book about recent trends in the U.S. political economy. He also worked as a journalist covering federal technology and cybersecurity policy for Nextgov, an Atlantic Media publication. Jack holds a B.S. in Journalism and a B.A. in Economics from Northwestern University.
Image: Dongfang / Shutterstock.com.