As you rightly point out, that's not a great argument.
2) China distills and is therefore possibly not that competent.
I think that makes sense. If they only catch up to the frontier through distillation then 1) Their model will never be as good as the model they are distilling from. 2) They will never reach the frontier - they need someone else to do it first.
1) China distills and is therefore morally bad.
As you rightly point out, that's not a great argument.
2) China distills and is therefore possibly not that competent.
I think that makes sense. If they only catch up to the frontier through distillation then 1) Their model will never be as good as the model they are distilling from. 2) They will never reach the frontier - they need someone else to do it first.