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Why China’s diversified economy garners both praise and criticism

Rarely do assessments of an economy’s performance and potential diverge as sharply as when it comes to China. Even as some economists laud China’s past achievements and future prospects, others fixate on presumed flaws in its development model and suggest that the middle-income trap awaits. But even more remarkable than the sharp divergence of opinions on China’s economy is the fact that both sides are able to marshal ample evidence to support their views.
Few would dispute that China owes its past economic success largely to technological imitation, enabled and encouraged by trade with – and direct investment from – developed economies, especially during the 1990s and in the first decade of this century. But one cannot pretend that translating technological imitation into rapid economic growth is not an achievement. After all, most low-income countries have not been able to do it.

In this discussion, pointing out that China still lacks a few key technologies, or that it obtained most of the technologies it has thanks to the allure of its huge market, is nitpicking. The true measure of technological success is the ability to convert new technologies into profits, growth and engines of development. And China has done that not only by using Western technologies in their original form, but also by rapidly upgrading and adapting them.

Today, China stands at the forefront of sectors like 5G, renewable energy, lithium batteries and electric vehicles (EVs), and it is a world leader in artificial intelligence. The question we should be asking, as former US Treasury secretary Lawrence H. Summers once noted, is not whether China’s technological prowess began with imitation, but how a country with a quarter of America’s per capita income has managed to produce so many world-beating tech companies.

According to Keyu Jin of the London School of Economics, the answer is simple: China is a truly innovative country. Western observers struggle to recognise that, because their perspectives on China are so politicised. But MIT’s Yasheng Huang insists that all China has done is repurpose Western technology, because entrenched Chinese traditions constrain innovation. Unless it can break those traditions, he concludes, economic decline is all but inevitable.

Both economists provide entire books’ worth of evidence for their analyses. How is this possible? One explanation might be that, in China’s highly complex political economy, many of the factors that can be regarded as incompatible with innovation are offset or complemented by innovation-enabling policies and structures.

People visit the green agriculture section at the China International Supply Chain Expo in Beijing on November 30, 2023. Photo: Xinhua
It has often been argued that top-down economic management in China – including the broad implementation of state industrial policy and the perpetuation of large state-owned enterprises (SOEs) in key sectors – is fundamentally incompatible with dynamism and innovation. Critics point out that excessive central government control can lead to economic inefficiencies, capital misallocation and financial distortions.

But even as the central government issues unifying policies and strategic documents, it also gives local governments ample room to encourage private-sector innovation, not least by establishing a nearly perfect pro-business environment. Though the degree of autonomy enjoyed by local governments is not static, policies tailored for the local economy are widely encouraged.

Moreover, China’s leaders understand that, far from hampering competition, subsidies can foster it. For a few tech firms to propel the development of an emerging industry, enormous entry barriers must be overcome. In most Western countries, support from developed financial and capital markets makes this possible but, even then, companies need ample time to achieve scale and competitiveness. Given that this entails high fixed costs, early subsidies are highly valuable – even essential.

In China, many local governments are willing and able to share these fixed costs, not only by providing subsidies, but also by establishing investment funds for emerging industries. This facilitates market entry by more companies, leading to the development of greater production capacity.

Manufacturing researcher Yang Xiaojun adjusts equipment at a laboratory in Xian, Shaanxi province, on January 17. Photo: Xinhua

Crucially, this capacity is distributed across various locales, with companies operating in highly competitive individual markets, rather than a single market. In this sense, China’s economic segmentation – which critics often cite as a weakness – is a source of strength.

China’s comprehensive industrial ecosystem means that firms gain a competitive edge from network externalities and economies of scale. This helps to explain the rapid rise of China’s EV and lithium-battery sectors – an achievement that critics attribute to China’s industrial subsidies and defenders attribute to a competitive domestic market environment.

For China’s critics, excessive bureaucracy, dominant SOEs, an underdeveloped financial sector and fragmented markets are militating against the emergence of a highly dynamic and competitive economy. And yet, as any long-time observer of China can tell you, the reality is not that simple. China is a vast country, with a long history of a single state, deep cultural traditions and a highly complex governance structure, which looks both centralised and decentralised, both rigid and flexible.

Top-down control coexists with – and even allows for – local-level autonomy and bottom-up innovation. It is this “double-helix” phenomenon that leads to radically contrasting analyses of the economy’s prospects.

Zhang Jun, dean of the School of Economics at Fudan University, is director of the China Center for Economic Studies, a Shanghai-based think tank. Copyright: Project Syndicate


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