Has the free-market approach to global trade become our nation's Achilles heel? Our leaders seem to believe that, if we sue China in the World Trade Organization often enough, it will comply with free-trade practices.

But the free-market ideals that spur prosperity through free enterprise in America differ from the practices that will open up genuine free trade with China. That is not because the free market lacks magic, as both Democrats and Republicans stress. It's that, in competition with China, the magic cannot manifest itself.

Why? China has invented a hybrid of capitalism that, on the one hand, uses free-market principles to spur homegrown enterprise, but on the other, state control to hobble rival foreign enterprises and build national champions. This hybrid knocks the magic from the free market's "invisible hand."

Magic is lost also from conflicting goals. The U.S. seeks a "level playing field." But China can't define "level" in the same way that the U.S. does. It is a country worried about starving peasants who don't own two bicycles let alone two cars. The U.S. also seeks "fair" trade. But China can't define "fair" in the U.S. way. It remembers to this day how colonial powers once humiliated it and drained its resources.

Why do U.S. leaders think they can browbeat China into accepting American-style trade? Why not instead - in a land of legendary innovators - reinvent our capitalist system to deal with the new reality? The question President Obama and Congressional leaders should answer is: What capitalist strategy will we use to win against China's hardball capitalism?

I give the answer in my recent book, "Strategic Capitalism": First, we need to admit that, however much we believe in our version of capitalism, the facts show that American capitalism needs serious modification. The U.S. suffers from a debilitating debt to China of $1.2 trillion,[i] a $295 billion trade deficit, and the astonishing loss to China of the number-one position as trading partner to a host of our major allies. China now trades far more with Japan, South Korea, and Germany than we do. Something big is going wrong.

If the U.S. were a company, we would call it Kmart or Yahoo or Nokia. It still runs, but it sputters for lack of a strategy for the new world. So how do we restore job-creating magic? How do we blunt China's appropriation of wealth? Three actions for our leaders to consider:

-- Restore Financial Health. First, reduce U.S. debt-to-GDP levels to 60 percent from over 100 percent today.[ii] Reinvent our capitalist system by blending free-market, managed, social-market, and philanthropic capitalism to counter the China non-free market advantages. Engage strategists-not politicians-to craft a plan that invests in research to create new industries; that nurtures industries that create jobs; and that protects selected industries hollowed out by Chinese hardball.

-- Seize the Initiative. Second, go on the offense against China. Relying on the World Trade Organization to enforce free trade has proven futile over the eleven years since China entered the WTO. If China flouts free-market rules, respond in kind: Close U.S. markets where China has limited or blocked U.S. success - like banking. Protect selected industries where China uses subsidies and other non-free market advantages - like renewable energy. Sign free-trade treaties only with allies, as in the Trans-Pacific Partnership. Free trade is only for friends.

-- Act Like a World Leader. Third, flex geopolitical muscle. President Obama has opened relations with Myanmar, stationed soldiers in Australia, tightened relations across Southeast Asia. All good, but we need to contain China's "going out" strategy: Double up our Pacific presence. Build alliances that exclude China. Withdraw from the WTO and G20 and found parallel organizations that exclude China. Create a Council of the Democracies for free trade among free nations.

These suggestions violate an article of faith in the U.S.: unfettered free trade and finance. So be it. We need to discriminate better in how we apply capitalist principles. Capitalism, like democracy, evolves. Past U.S. leaders recognized the economic and democratic system had to evolve to counter economic threats - the monopolies of the Robber Barons, the abyss of the Great Depression, the rise of World War II, the Japanese quality revolution. Our leaders went beyond rearranging deck chairs on the economic ship. They redesigned the ship.

We need a better way to counter China's state capitalism. Free-market mechanisms cannot do it alone. While free markets helped turn the tide with Japan in the 1990s, China is no Japan. China is less beholden to the U.S. for military protection and economic aid. And China is much larger. The challenge posed by China requires more serious reinvention of the American free-market system - reinvention that will speed regulatory approvals, protect key industries, create new industries, and reorganize the federal government to cooperate better with the private sector.

What kinds of civil, business, or military leaders close their eyes to competitors' countermoves? None. They study rival strategies, devise new approaches, and execute ingenious plans to win. That's the American way - it's time for our political and economic leaders to quit rearranging chairs and get in the game.

Richard A. D'Aveni, Ph.D., is Bakala Professor of Strategy at Tuck School of Business at Dartmouth College in Hanover. The preceding was adapted from his new book, his fifth, "Strategic Capitalism: The New Economic Strategy for Winning the Capitalist Cold War." It is used with permission.