How should we measure economic power?

What is economic power? How should it be measured? Earlier this spring, my Fletcher School colleagues and I convened a fascinating workshop on the topic of supply chain conflict. Ben Vagle, co-author with Stephen Brooks of the excellent new book Command of Commerce: America’s Enduring Economic Power Advantage over China, presented an argument that the best metric of power is not production, but profit.

For most recent economic history, it wasn’t considered necessary to distinguish between production and profit. In Rise and Fall of the Great Powers, Paul Kennedy noted that “in a long-drawn-out Great Power (and usually coalition) war, victory has repeatedly gone to the side with there flourishing productive base—or, as the Spanish captains used to say, to him who has the last escudo.”

The assumption that whoever has the last escudo can muster more resources has been a pretty accurate guide to international politics over the past two hundred years. Yet it is increasingly in question. The richest countries are richer because of their production of software and professional services. The correlation between ‘knowledge economy’ outputs and military power has not been seriously tested. Palantir and Maven stand on one side of the equation. China’s vast drone production base stands on the other. Ukraine, it should be noted, has acquired a vast quantity of drones (full of Chinese components, as Cat Butchatskiy explained in this fascinating podcast that Jordan Schneider and I hosted). But Ukraine has also built some pretty impressive software to coordinate these drones.

What do we know about production, profit, and power? Among analysts of international politics as well as government officials, the idea that profit equates to power is therefore increasingly a minority view. The dominant perspective is that manufacturing output matters—in peace as well as war.

China’s rise to becoming the world’s largest manufacturer has dramatically enhanced its power. Beijing deploys this influence in a range of sectors, from batteries to magnets to minerals. It has weaponized market dominance by restricting access of key products to specific companies and countries. It has also coopted key Western manufacturers, convincing them to locate a substantial share—and in some cases all—of their production in China.

Over the coming years, China’s share of world manufacturing value add will approach 40%, which may be nearly triple America’s. China’s production base is uniquely low in profitability. Yet perhaps “quantity has a quality all its own,” as both Napoleon and Stalin are quoted as saying. If output matters most, China’s poised to get even more powerful.

Though the world’s largest Marxist-Leninist power has chosen to maximize output—building this vast industrial base—a long tradition since Marx emphasizes the importance of profit instead. The argument is that profit results from power imbalances, within and between societies. Whoever has the power, the analysis goes, reaps the profit.

In Command of Commerce, Brooks and Vagle take a similar line. Profit, they argue, is evidence that one company can do something others can’t. Monopolists have the highest profit. Oligopolists make good money. Manufacturers of toys and textiles have razor thin margins. When Brooks and Vagle measure profits, they find that U.S. firms dominate, while Japan and Europe remain significant players. China is a second-tier player.

See the below charts from Brooks and Vagle: the U.S. and allies lead in profits across the board. When it comes to high tech products, the imbalance in America’s favor is particularly pronounced. If profitability is the result of power dynamics, then the U.S. is far more powerful than comparing GDP or industrial output implies.

There are a couple of potential counterarguments. First: shouldn’t we expect a Leninist political system to prioritize output not profitability? Profitability helps the business class, whose loyalty to party rule is questionable at best. Is it really surprising that China’s leaders have allowed the least necessary profitability? For Beijing, the optimal profit level is high enough to keep China’s capitalists incentivized to support GDP growth, but no higher, to prevent accumulation of resources that could buy additional political power (the Jack Ma problem). In this reading, China’s low profitability could be the result of domestic political choices rather than Chinese firms’ reduced influence in global markets.

The second counterargument is: perhaps China’s pursuing a loss-leading strategy, accepting low profits in the short run to win market share in the long run? In solar power, China’s commoditized the sector and produced overcapacity that’s led to losses, not profits. There’s no moat in solar the way there is around tech.

Batteries, though, appear different. CATL has a sufficiently deep technological moat that markets value it around $300 billion. That’s less than a tenth of US big tech firms, but it’s more than any car firm (excluding Tesla.) CATL one of the world’s most valuable manufacturers. If China can do in other sectors what it’s done in batteries, perhaps more profitability is to come. I don’t think China’s proven it has a durably profitable moat around EVs, but BYD did overtake Tesla last year on profits (though they’ve slumped this year).

The third counter is: perhaps profitability’s the right metric in peace but not in war? Jordan Schneider of ChinaTalk and I have been debating who you’d rather have on your side during a protracted conflict: Apple or Xiaomi? Apple has extraordinary software and supply chain management expertise. Its chip production is outside of China. But most of the rest of its manufacturing base is in China. Xiaomi does not have differentiated software or services. It depends on imported chips. But it can source most of its other components domestically. Measured by profit, it’s not even close. Measured by production capabilities…Jordan and I are still debating.

Yet framing the debate as production versus profits is too simple. As CATL demonstrates, production volume can spur learning that creates moats. The causality sometimes works in the opposite direction, too: profit can also reshape production networks. Several weeks ago, Patrick McGee, author of Apple in China, published an illuminating two part series in the Financial Times on the origins of Apple’s supply chains. Patrick writes:

Apple would identify the best supplier for a component, then actively teach its rivals the secrets of their manufacturing process until no differences between them remained… The iPod Classic became a case study. It had a beautiful stainless steel back, 0.4 millimetres thin, and reflective like a mirror thanks to precision hand polishing. Apple had worked with a master craftsman in Japan to develop the process and, within a few years, more than 20 companies were working in co-operation on 15,000 to 20,000 iPod casings per day.

Once the iPod ballooned in popularity, these artisans couldn’t keep up. That’s when the film crews showed up. Apple recorded every step of the process — the angle of the craftsman’s wrist, the pressure and speed and sound of the polishing, and how to manage the heat distortion without warping the metal. Then Apple broke down each step into mathematical code and automated it all, at gargantuan scale, in China.

Why would companies agree to this? Well, profit. Patrick explains:

Using the carrot of a major iPhone order, Cupertino could routinely exert enormous leverage to own the IP — even if its suppliers did most of the work and R&D funding.

That’s power. But Patrick also finds supply chain executives themselves questioning themselves. As one of Patrick’s sources puts it:

“Longer-term, big macro view, I think the Chinese stepped back and said, ‘Well, if we’re making it all, that’s power,’” says a former Apple operations manager.

Vishnu Vengolopan and I tested this assumption in a report a year ago that examined Apple suppliers by factory location versus company headquarters. The factory locations are disproportionately in China. But for many types of production, Apple relies on companies with foreign headquarters—and thus presumably a lot of foreign know how. This isn’t only in chips, which are mostly sourced from non-Chinese firms. Even in segments like connectors and cables, Apple’s suppliers are disproportionately non-Chinese. (Caveat: we only have data on number of suppliers, not dollar spend per supplier, or number of components sourced per supplier.) A company’s headquarters has more power than a factory it owns. So perhaps less power accrues to China from Apple’s China-centric manufacturing base than one might expect.

Most Western governments, however, fear that production equals power. That’s driven some to start targeting industrial production capacity as a goal in itself. The European Union’s Industrial Accelerator Act targets manufacturing at 20% of the bloc’s 2035 GDP—far above Europe’s current 14.3% manufacturing share of GDP. In Japan, the Ministry of Economics Trade and Industry has similarly embraced the thesis that aggregate industrial capacity matters, and that “point-based” efforts to protect certain critical technologies will fail if the country’s broader industrial base erodes. US political leaders of both parties embrace “reindustrialization,” at least rhetorically.

Reindustrialization defined as the EU has—as an increase in the manufacturing share of GDP—seems highly implausible over the next few years, particularly given how AI seems poised to supercharge services output. Reindustrialization defined as rebuilding the defense industrial base seems plausible, but far too narrow a goal if you believe that aggregate output equals power in a protracted struggle.

I come down somewhere in the messy middle. The output-focused school is correct that having profitable pharma companies but no API production is a position of weakness, not strength. Yet Vagle, Brooks, and the Marxists are clearly right that power and profits are linked.

What’s clear is that we need better understanding of the ways profit can recast production networks (like how Apple used its economic heft to reshape electronics supply chains in the 2000s) but also when and how production scale enables future profits (like how China’s battery investments and local content requirements enabled CATL).

China is betting that its production advantage will create more durable CATL-style moats that eventually enable both profit and power. Western firms are making a calculated bet that their profitability provides flexibility to recast production networks if needed. Western governments, meanwhile, increasingly fear their firms are naive and that China’s strategy just might work.