I'm not saying that the USA isn't in the lead, only that the US government seems somewhat out of touch. If US government labs are secretly ahead of industry on AI, they're doing a very good job of keeping it secret.

Chinas advantage is in manufacturing

No, that's their main advantage that funds their other activities. That's their thing that most Americans know about China, which isn't saying much. They also have insane tech talent, as does North Korea, because they start teaching/hiring teenagers to work for them, with all that extra neuroplasticity, and they're happy to 'help.'

China leads everyone else in the world in leapfrogging via industrial espionage. They don't need to do the backbreaking work of creating paradigm shifts in physics, tech, engineering, they only need to have people who can understand and implement it.

You'll see this in academia as well, Chinese students are far and away more aggressive cheaters.

In Chinese culture it doesn't matter how you get ahead as long as you aren't hurting family or the state, the ends justify the means.