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The War Economy: Batteries and drones
Target #2 for industrial policy
This is the fourth post in a series about how international competition could reshape the U.S. economy. The first post, giving an overview, is here. The second post, comparing the strength of the two emerging blocs, is here. The third post, assessing China’s advances in scientific research, is here.
Transforming the U.S. economy in order to more effectively compete with China and Russia will involve industrial policy. There’s a very basic economic reason for this. The industrial structure that the free market will tend to produce if left to its own devices does not take national security — or indeed, any political considerations — into account. Thus, if we want to have an economy that’s optimized not just for consumption but for protecting the nation and its allies, government will have to put its thumb on the economic scales in some way. This certainly happened in past wars like the Civil War and WW2, but industrial policy is not purely a wartime tool. During the Cold War, the U.S. built the interstate highways, the modern university and national laboratory systems, and a strategic trading regime. Luckily, those actions probably eventually increased national consumption as well, when private industry benefitted from Cold War infrastructure and innovation.
Anyway, competition with the China-Russia axis is heating up, and it’s time to think about what sort of industrial policies the U.S. can use to meet the challenge. In an earlier post, I explained why the first order of business — and the focus of the flawed but important CHIPS Act — is to shore up the U.S. and its allies’ domination of the all-important computer chip industry.
Today I’m going to talk about another major cluster of high-technology industries that the U.S. should target with industrial policy: batteries and drones.
Currently, China dominates both of these industries. Most of the lithium-ion batteries in the world are made in China:
China is also incredibly dominant in commercial drones, with its top company, DJI, taking a commanding 76% market share worldwide as of March 2021.
Building up market share in batteries and drones will therefore be a very different sort of industrial policy task from the typical notion of protecting or maintaining the U.S. lead in some industry. If we want to have a major position in batteries and drones, we will have to actually poach these industries — China is the leader in these areas, and we are the follower.
That’s going to be a difficult task, for several reasons, but I think it’s actually pretty doable. First, though, let’s talk a bit about why it’s important for the U.S. to maintain a position in these industries.
Why batteries and drones are important
Recall that computer chips are strategically important because they’re an essential component in basically every part of modern warfare. For batteries, it’s not so clear. Some military vehicles may be powered by batteries in the future, but many will probably continue to run on diesel, jet fuel, or other fossil fuels for quite some time. This is because planes, ships, tanks, and other military vehicles tend to be quite heavy, and we don’t yet have batteries that can easily and cheaply power very heavy things. That said, as battery capabilities improve, some military vehicles may make the switch.
There is one incredibly important type of military vehicle that is battery-powered, however: small drones. Quadcopters and other small hovering vehicles have become extremely important tools in the Ukraine war, both for reconnaissance and for actually delivering weapons. Here are just a few examples out of the many I’ve seen (plus one from China):
Ukraine is certainly taking drone warfare extremely seriously, devoting a good amount of brainpower to rapidly developing new ways to use drones in combat.
And it’s likely that small drones will only become more important to warfare in the future. A number of research teams in China, the U.S, and elsewhere are experimenting with autonomous swarms of small drones. The widespread deployment of such weapons systems could render human beings nearly obsolete in close combat, and provide improved fire control to distant artillery.
This is why the U.S. needs a drone industry. Now, it’s possible to simply have a government-facing drone industry that only sells to the military, while remaining uncompetitive in civilian markets (this is basically what we do with shipbuilding). But making drones for the commercial market spurs innovation and competence in a way that defense contracting might not. For example, China’s dominant market leader, DJI, is learning how to make drones for a variety of civilian applications such as crop spraying, but the know-how and innovations gained in this effort.
But batteries are important as more than just an input to drones. They’re also the key component of electric cars, which are turning into a huge industry. Auto exports have always been important to the U.S. And in a couple of decades, most of the cars on our roads will be EVs. Even if we retain significant EV production capacity — which shouldn’t be that hard, because cars are mostly made in the same region they’re sold in — that industry will be dependent on a steady and massive supply of batteries. And if China controls the supply of batteries, they could cut off the lifeblood of the U.S. economy using export restrictions if they so chose. That’s a very vulnerable and dangerous position for the U.S. to be in.
And it’s increasingly not just electric cars. Batteries are likely to be important in a number of other industries, including robots and e-bikes:
Letting China maintain dominance in battery manufacturing means that U.S. robotics and other emerging industries will also be subject to strangulation by our chief foreign rival.
Why China dominates batteries and drones
So if the U.S. is going to build up significant positions in batteries and drones, we need to think about why China dominates these industries in the first place. In fact, there are at least three major reasons.
Reason 1: China dominates the refining of the minerals that go into batteries.
Lithium-ion batteries require four main minerals: lithium, nickel, cobalt, and graphite. In terms of mining, China dominates only in graphite, but there are plenty of supplies elsewhere, in countries friendly to the U.S. Mining isn’t the problem. The problem is that China dominates the refining of these minerals into forms that batteries can use:
Refining minerals is one of those low-end, un-sexy “primary” industries that takes a lot of capital and doesn’t make a lot of profit. This is exactly the kind of industry that American companies have been loath to enter for the past two or three decades; instead, they stuck to the high-value-added ends of the value chain. In pure profit-maximizing terms, this was a rational thing to do, but it left the U.S. dependent on China for critical components. That’s why in the 20th century, many countries strove mightily to develop refining industries, even though they knew that those industries wouldn’t be the ones that raked in the bucks. If the U.S. wants to break China’s stranglehold on the battery industry, we will have to do the same. (Luckily, some companies like Tesla are already looking into this.)
Reason 2: China is zooming ahead in EVs
EVs are one of the most important uses of batteries, and they’re the use case that’s driving the most scaling and innovation in the space. And China has gotten the jump on the rest of the world in electric vehicle production and sales:
A big reason China was able to zoom ahead in EVs is that they started from scratch. They had less of a gasoline-powered car industry than developed countries, less car ownership in general, and fewer gas stations. That allowed them to leapfrog the developed nations and go directly to the hot new thing. A second reason was that China’s massive electronics industry had already given it a lot of expertise in battery production, which was helpful in developing car batteries.
As I said before, I’m not very worried that the U.S. will be left without an EV industry. Cars are very heavy, so most cars are made near to where they’re sold. The global auto industry is thus highly fragmented rather than dominated by one or two countries. I’m pretty sure this will continue to hold in the age of EVs. And once we start switching to EVs en masse — a transition that has already begun and will be sped along by recent legislation — our demand for electric car batteries will increase. And since these batteries are themselves quite large and heavy, it will make sense to make these batteries in the U.S.
Reason 3: China is the center of global consumer electronics manufacturing.
This is the hardest obstacle to get around. Industries that are part of the same supply chain tend to cluster together. In the past four decades, East Asia has become the hub of the global consumer electronics supply chain. And China is the center of the East Asian electronics manufacturing; Japan, South Korea, and Taiwan are still important, and Malaysia and Vietnam are up-and-coming, but China outweighs them all by a lot. China makes our iPhones, our PCs, our appliances, and all our other devices.
This isn’t the economic catastrophe it’s often made out to be — the U.S., Japan, South Korea, Taiwan, and other rich countries still do electronics design and still manufacture many high-value components, such as the aforementioned computer chips. But because China is the place where electronics are assembled, it makes sense to have battery factories nearby. (Of course, it also makes sense to have factories for every other component nearby as well, but because of China’s technological limitations, those factories are often in Japan, Korea, etc.)
China’s dominance of batteries and drones are thus mutually reinforcing. It makes sense to make a lot of drones in China because they have lots of battery manufacturing nearby as a source of supply. And the fact that nearby drone factories are a source of demand makes it economical to make batteries nearby (though the main demand sources are other consumer electronics and EVs).
Of the three factors I mention here, this will be by far the hardest to overcome. As long as East Asia remains the electronics manufacturing hub of the world, China can retain its position as the center of that hub. And as long as China is the world’s most important electronics manufacturer, it will make economic sense for it to also be the world’s main maker of batteries and drones. In order to poach these industries, the U.S. will be struggling not just against purposeful Chinese competition, but against vast, impersonal economic forces.
Coming from behind
So how can the U.S. come from behind and build thriving battery and drone industries? The first big step is to simply switch very rapidly, to electric cars, which we are already doing. That will create an economic rationale for locating plenty of factories for big heavy car batteries in the U.S. This also applies to large, heavy battery packs used in robots, appliances, etc.
The second, harder step is to encourage the creation of refining/processing industries for lithium, nickel, cobalt and graphite. This will require overcoming fierce local NIMBYism (but then again, every other important important task in the U.S. economy will also require the same). A second issue is that refining is simply a low-margin, capital-intensive business. So government policies should provide subsidies and tax credits for the lithium/nickel/cobalt/graphite processing business, while guaranteeing it a modest but reliable profit margin. This is already what we do with utilities, so the model already exists.
If we can do both of these things, we can build a domestic battery industry. It will be heavily weighted toward big, heavy batteries; small, light batteries will still probably be made in China, which will continue to be the center of consumer electronics manufacturing. But factories for big, heavy batteries will probably give us the capability to also make small, light batteries in case of a war or protracted conflict with China, dramatically reducing our vulnerability to export restrictions.
Building a robust domestic drone industry, however, will be the hardest. Military procurement is crucial, but it’s no guarantee of success in the civilian sector. Our best bet here is innovation. The U.S. managed to become the main designer of PCs in the 1990s, and smartphones in the 2010s, through constant innovation by companies like Dell and Apple. The assembly of these products sooner or later migrated to China, but the U.S. and our developed Asian allies retained control of the designs and a lot of the high-value component manufacturing.
We need to do the same thing with drones. Whether it’s Apple, a defense contractor like Skydio or Anduril, or some plucky startup being led by the next Steve Jobs, the U.S. needs to innovate in the commercial drone space. Whether that means delivery drones, crop spraying drones, toys, or some other application, I don’t know. But the government should focus on creating a regulatory environment that will allow these and other uses of drones in civilian life.
In other words, catching up to China in batteries and drones will require a mix of demand boosts and regulatory reforms. It’s a tall order, but I think it’s far from impossible.