Building a More Resilient Economy
An Initiative by
In a presentation shared widely on Chinese social media, Chen Li, chief economist at Soochew Securities, declared: ‘We have abandoned the American path to the German path.’ Chris Leung, chief China economist at DBS Group Holdings, soon echoed the sentiment: ‘The departure of Beijing from the Anglo-Saxon model has already begun … The German model is a strong contender as a guiding development model.’
What is this ‘German model’, and how does it tie in with Beijing’s global ambitions? While Germany’s state-owned banking sector and strong anti-monopoly laws have much in common with China’s, what most defines the German development model, and has delivered the country to economic prosperity since World War II, is a focus on manufacturing. Beijing’s current five-year economic plan aims to keep manufacturing at 25 per cent of gross domestic product (GDP) – a level comparable to Germany’s 18 per cent, but much higher than the United States’ 11 per cent. Some say this reveals China’s desire to continue to be a manufacturing-based superpower – an ambition the government has been vocal about, but surprisingly few outside China seem to have grasped. Is this true? And if China continues as a powerhouse of product, what are the implications for the unfolding geopolitical technology competition?
The past year has seen a flurry of regulations governing China’s booming internet companies. In the last six months alone, there have been twenty-five new laws related to everything from worker compensation to videogaming. They have contributed to what the media has dubbed a ‘trillion-dollar stock market meltdown’ as companies go into a tailspin trying to determine the implications for their business models. Clearly, China does not want to follow the US path of being dominated by internet monopolies.
At the same time, the government has declared its intention to alleviate ‘chokepoints’, where products must be imported, highlighting China’s reliance on foreign technology for the manufacture of goods, from pharmaceuticals to semiconductors. This has led some to believe the intention is to direct resources away from the digital sector and towards manufacturing.
Yet the truth is that China’s aim is not to grow manufacturing at the expense of technology, but to encourage growth that benefits the real economy.
The rising digital economy
Chairman Xi Jinping has no intention of China becoming a ‘post-industrial’ nation with little manufacturing, even as it seeks prosperity and power from digital dominance. Xi has made clear that China’s digital goods and services are an asset. In particular, its e-commerce infrastructure is credited with accelerating economic development and improving living standards. China intends to export these consumer internet models to developing countries in what’s called the Digital Silk Road, the technology component of the Belt and Road Initiative. It has also set up various incentives promoting cross-border e-commerce and rural e-commerce, emphasising investment in rural infrastructure.
In fact, most of the government’s new regulations are less prohibitive than many think. Aside from a few idiosyncratic rules such as limiting minors’ videogaming hours, they are either rectifications – such as antitrust law for digital platforms, which brings the lightly regulated Chinese ecosystem closer to conditions in the West – or world-leading innovations, as with rules for emerging technologies such as AI recommendation algorithms.
There is the part of the digital economy that feeds the real economy, such as traditional e-commerce, livestreamed e-commerce (aka live shopping) and fintech (loans that allow for more consumption). There are other parts that have less impact, such as cryptocurrency, which China categorises as speculation. Given that China’s focus is growing the real economy of goods and services, as opposed to the financial economy of fiat money and assets, the distinction between the real and the financial economy is much more important to it than that between ‘hard’ (science-oriented and manufacturing-based) technology and ‘soft’ (consumer internet) technology.
Growth is king
In late 2020, the Chinese government proposed at an economic meeting that the share of GDP from manufacturing should not fall below current levels. Li Chen, in his recommendation that China take ‘the German route’ over ‘the American’, is referring to the fact that Germany’s manufacturing output as a percentage of GDP has largely remained stable in the last two decades while America’s has declined.
It is not difficult to understand China’s motivation. The ongoing US–China trade war and geopolitical tensions, exemplified by sanctions against Huawei, highlighted to China that supply-chain integrity and manufacturing self-sufficiency are matters of national security. If those lessons were not vivid enough, the Covid-19 pandemic has proven them beyond doubt. It was inevitable that China would conclude upgrading manufacturing to more advanced levels is a national priority.
But this is not just about manufacturing. Ultimately, China realises that its greatest weakness is its lagging accomplishments in scientific research and commercialisation. Addressing this does not need to come at the expense of China’s increasingly digitised society, which is enabled by its largest internet companies. The government’s intention is to support technology that grows the real economy without incurring negative social and political costs. As such, technologies that generate efficiency gains for the real economy will receive incentives, even if they do not directly alleviate chokepoints. Senior economic adviser Huang Qifan illustrated with the example of a smart logistics company. Such a business does nothing to alleviate, say, China’s semiconductor crisis, but it enables greater velocity in the supply chain, thereby tangibly growing the real economy.
The challenges ahead
There are several implications for the unfolding geopolitical technology race.
First, there will be no let-up in competition from China: the government wants to dominate in both technology and manufacturing. Xi Jinping has proclaimed, in what has become a common refrain, that ‘one of the roots of China’s fall’ was the country’s ‘backwardness in science and technology’. This has been China’s lesson from its bitter defeats of the last two centuries, and it is now made even more urgent by US tech sanctions and bans.
China was never going to be content to be the world’s factory without its own intellectual property. Of course, whether it can achieve this dominance is uncertain, as other countries, such as Germany, reassess their engagement with China.
Second, now that China has conquered low-cost manufacturing, its goal is to upgrade while maintaining basic production capabilities. Supply-chain resilience is the aim. But China is going to face an increasingly diverse and competitive global market, with countries such as India and Vietnam competing in low-cost manufacturing.
Third, China’s model is reliant on exports, at least until domestic demand can be ramped up to keep pace – as we saw with solar technologies and are perhaps seeing with electric vehicles. This means China will seek to sell and embed its technologies into global networks, such as 5G and its successors; but as countries reassess their terms of engagement with China, and as international competitors emerge, it will become increasingly challenging for China to sustain the export-led model.
The Chinese real economy has benefited not only from manufacturing but also from its digital technologies and services, including the very consumer internet platforms the government has been regulating. China’s physical and digital goods and services are complementary: we can expect Chinese digital platforms to be exported abroad, along with products derived from Chinese manufacturing. China is aiming to build a more resilient economy, and the Indo-Pacific best prepare itself for the results.
