Opinion
We are in a frantic race for post-industrial dominance
Summary
- Industrial policy has reached epidemic levels globally. It is playing a role that’s subject to the risk of resources being misallocated by policymakers.
The scale of investment by the world’s two superpowers as they conduct a proxy war through aggressive industrial policies is epic. Given the opaque nature of China’s Communist Party government, the most cited estimate is that even five years ago, China was spending 1.7% of GDP on industrial-policy projects. That ratio has surely gone up since. This January, the government expanded its goals to include an emphasis on “photonic computing, brain-computer interfaces, nuclear fusion," according to The Economist, and in a classic Beijing micro-management mandate, decreed that research institutes “spend more than half of their basic funding on scientists under 35 years of age."
The US spends less than China as a proportion of GDP, but a JPMorgan report last year estimated that the three bills passed in 2021-22 with industrial policy aims would lead to investment of $2.4 trillion.
Some find it fashionable to credit China’s leaders with omniscience, but despite China’s lead in, say, manufacturing large battery cells, electric cars, wind turbines or solar panels, US efforts seem better aimed. Improving its creaky infrastructure and making semiconductor chips are worthy goals, especially given the real danger of Beijing invading Taiwan, which dominates global chip production. The risk for the US is that these initiatives might over-stimulate its economy and keep interest rates high. For Beijing, it is larger still—public debt could rise to unsupportable levels.
Beijing’s industrial policy dividends have been impressive thus far. The Rhodium group estimated that in 2020, China’s spending on science and technology was 2.8%. The Economist in April quoted the Australian Policy Institute’s list of 64 “critical" technologies and said that China leads the world “in all but 11." The list suggests China leads in 5G and 6G telecom, drones, radar and robotics. At many levels, China is a serial overachiever. The same article pointed to an index published by the World Intellectual Property Organisation that uses yardsticks such as infrastructure, patent awards and citations. “A middle-income country with China’s GDP would expect to rank in the 60s. China ranks 12th."
So far, so impressive—if occasionally so gullible. There have been questions raised about the Chinese race to publish intellectual property papers, for example, and the country is yet to build gigantic chip manufacturers such as Taiwan’s TSMC.
The real challenge, though, is that President Xi Jinping’s China has kept investment as a proportion of GDP at above 40%, a distorted-reality view of economics, while effectively suppressing domestic household consumption. Gross capital formation in China is 43.3% of GDP. By comparison, the OECD average is just 23.7%.
It is becoming harder to argue for Chinese exceptionalism in fiscal management. Xi seems keen to emulate the Soviet Union’s late Nikita Khruschev in his threats aimed at the US in the context of a post-industrial race for the future. But the backdrop of a housing bubble deflating and impoverished local governments—an integral part of China’s alternately impressive and wasteful infrastructure rollout of the past couple of decades—hurtling towards de facto bankruptcy would make these grand plans difficult to achieve.
Bloomberg estimated that at the end of 2022, property developers owed $2.5 trillion while local government financing vehicles owed $13 trillion. This is a debt problem on the scale of Japan’s after its bubble burst in the early 1990s, but with less capable macroeconomic management. The FT reported recently that directives from the State Council to 10 highly indebted provinces and two large cities barred them from building more highways and government buildings. Banks have been directed to lend to high-profile manufacturing projects instead that President Xi has clunkily called “new quality productive forces."
Even economic experts are voicing concern, which takes special courage in Xi’s China. The truth is that we have seen this movie before. Earlier versions starred China taking advantage of its 2001 accession to the World Trade Organization (and the world’s naivete) to dump products in markets abroad because large-scale subsidies had been part of its game-plan well before industrial policy became the global epidemic it has in recent years.
In a chilling chart, the JPMorgan report shows that in the decade from 2010, opioid use in the US rocketed, inversely tracking the loss of manufacturing jobs there. “A total of 5.7 million factory jobs (in the US) were lost from 2000 to 2010—nearly 10 times more than during the previous 30 years, from 1970 to 2000." The political climate in the developed world will no longer allow China to export its way out of the economic doldrums, heightening the risk of massive overcapacity in future-focused industries.
By comparison, India’s industrial policy seems a familiar tale of too little, too… er, too little of it thought-through, actually. It is hard to categorize a subsidy scheme for textiles or white goods as ‘strategic’ when the sensible thing would have been to sign free trade agreements with the EU years ago to allow our garment exporters to compete on a level field. Mint reported recently that imports from China grew from $70.3 billion in 2018-19 to $101.75 billion in 2023-24. Are we really weaning ourselves off Chinese exports? As an IMF report notes, well designed policies to improve the business environment would have been better than targeted government interventions that carry the risk of resources being misallocated.
