The trade war started by the United States against China has been designed as the response to the MIC2025 initiative, the first of a three-stage plan aimed at establishing China as global manufacturing and technological power by 2049.* It is widely acknowledged that China’s industry is today very large – the so-called world factory – but not technologically strong. It is the world’s largest producer, since 2015, in a growing number of manufacturing value chains, including mobile phones (over 90% of the world’s total production), computers and air conditioners (over 80%), TV sets (over 60%), refrigerators (over 50%), ships (over 40%) and automobiles (almost 30%)(according to data reported by the European Chamber of Commerce in China).
However, in most cases, China only enters the downstream stages (mainly labour-intensive production and assembly lines) through assembly or licensed production of imported technology inputs. The world factory is the result of three decades of massive capital investment together with import or acquisition of foreign technology that feeds into China’s processing lines to be assembled into final goods shipped to consumers around the world. The share of Chinese domestic value added in many of those industries is still rather low, which means that for each dollar of exports, less than 50%, on average, is truly manufactured in China.
MIC2025 aims at transforming China’s industry from large to strong, by investing in Research & Development, setting high domestic content requirements, while protecting the industry from foreign competition. This goal of achieving industrial upgrading to become the world leader in a number of advanced sectors further adds to the international resentment over China’s modalities through which Beijing has acquired technical skills, i.e. imports and acquisitions over the last thirty years. Technology acquisition has often been unfair and has sometimes turned into illegal technology transfer, while disregarding intellectual property, discriminating against foreign firms, and using preferential industrial policies to strengthen Chinese firms. Trump’s trade war is, therefore, a full-fledged counteroffensive to China’s ambition of becoming a global economic superpower. However, it has repeatedly been emphasised that a trade war might not be an effective countermeasure to China’s global ambitions, and it will imply a net welfare loss at the global level. Why might a trade war be ineffective in containing China and how likely is it, after all, that China might eventually achieve her goal? The comparative history of East Asian economic and industrial development offers quite a number of suggestions about this.
First of all, needless to say, China is not the first country to launch such a global challenge to win the global technology race. Before China, Japan in the 1950s and 1960s, as well as South Korea in the 1970s and 1980s also aimed to transition away from labour-intensive industries and climb the value-added chain. Both of them succeeded in achieving industrial upgrading and escaping the middle-income trap, but neither overtook the United States in terms of overall economic size and technological leadership. They did join the club of advanced, industrialised, high-income countries, but nothing happened about what was feared of Japan in the 1980s, i.e. that eventually Japan would overtake the West in all sectors.
Nowadays, MIC2025 scares many industrial powers with the threat of new actors entering the race for global technological supremacy. According to the Asian Development Bank, China ended Japan’s dominance of Asia’s high-technology export market in 2014, when it accounted for 44 percent of shipments of high-tech goods such as medical instruments, aircraft and telecommunications equipment -- up from 9.4 percent in 2000. China is quickly turning into a strong power in areas ranging from renewable energy to electric cars, and is moving closer to mass-producing its own airliners. No wonder that the world now fears China for what everybody feared Japan back in the 1980s: MIC2025 shares many similarities with Japanese industrial policies (introduced between the 50s and 60s), which subsequently led to the economic boom that made Japan the world's second largest economy for 40 years, until China overtook that position.
China today is introducing a somehow similar industrial policy to that of Japan in the Golden Sixties. Both countries have pursued massive state-run development, heavy industrialisation through subsidies and over-loaning to big conglomerates, who borrowed well beyond their capacity to repay. In both cases, state agencies succeeded in aligning business incentives to collective outcomes, i.e. managed to make long-term goals prevail over short-term economic gains (i.e. profits).
The aim to increase domestic manufacturing content makes MIC2025 something no different from an import substitution policy, which was what happened in Japan. Similarly, the aim to increase China’s foreign market shares parallels that of Japan.
However, there are also fundamental differences. In Japan, the government limited itself to providing a vision and administrative guidance, without direct intervention or massive incentive programs. In addition, the financing through the banking system passed through the channel of private financial institutions, which followed the seed-financing granted by some (few) public banks, but were mainly driven by the competition between groups. It was an industrial and export-promotion policy based on competition among private actors, who were invited to coordinate, especially - if not exclusively - in the phases of economic slowdown. In Japan, with rare exceptions, there were no state-run enterprises. Moreover, foreign direct investments were few and discouraged, unlike in China. In short, Japanese companies and private groups were much more solid and competitive: they attacked foreign markets after gaining a share of the large, then expanding, domestic market.
Moreover, one further difference with Japan’s industrial policy, i.e. the timing of the import-substitution and export-target mix vis-à-vis the growth of the internal market, makes the Chinese plan more worrying for the rest of the world.
Unlike Japan, which was rather isolated commercially from the rest of the world, China is today well integrated into a vast number of industrial sectors in which it plays a significant role either as a final market or as an important supplier. Admitted but not granted that it will not violate WTO rules against technology substitution, MIC2025 sets targets for achieving 70% “self-sufficiency” in core components and basic materials in industries like aerospace equipment and telecommunication equipment by 2025. A massive import-substitution policy by China with the aim to achieve “self-sufficiency” would be most disrupting for supply chains and corporate profits around the world, most notably in countries like South Korea and Germany, where high-tech sectors are heavily intertwined with Chinese firms and constitute a large share of industrial output and exports.
There are other crucial differences between Japan’s policies for industrial upgrading in the decades after WWII and China’s today. Long-term sustained industrial development in Japan – the Japanese economic miracle – was established through private sector growth, by introducing regulations and protectionism and only later by focussing on trade expansion. The Japanese keiretsu (a set of companies that share common business activities) went through serious economic improvements and restructuring that spurred an efficient allocation of resources and made them competitive internationally. On the contrary, state-run development in China is often highly inefficient, in that the government usually grants funding, irrespective of the degree of success, be it on export markets or on internal improvements. This is likely to turn a large percentage of the government’s support inefficient, as many firms will enter the market to profit from subsidies in the short term instead of developing long-term competitiveness.
What happened in Japan since the early 1990s is very instructive about the possible scenarios for China’s ambitions. By the 1990s, population growth started to slow down and the workforce was no longer expanding as it did in previous decades. Nonetheless, productivity (per worker) was and remained high. China’s development trajectory presents similarities: as population growth declines and wages rise, the need is more urgent to find new sources of productivity growth. However, productivity in China is not as high as it was in Japan in the same stage of industrial development. This makes it much harder for China to establish new sources of growth, most notably because the overall global advancement of manufacturing continues and the technology frontier stretches continuously ahead. Maybe this is why, in the incipient fourth industrial revolution – the digitisation of manufacturing – China’s aim of increasing “indigenous innovation” often reads as developing Chinese technology and products, “through co-innovation and re-innovation based on the assimilation of imported technologies”. This is a long way to go to become an industrial superpower.
While "reciprocity" has been widely advocated as the right approach in economic and trade relations with China, by Trump and by most other industrial economies, the ongoing evolution of manufacturing could seriously challenge China’s twentieth century-type industrial approach for the twenty-first-century industrial advancement. Increasing servicification of manufacturing today implies a high service value added in manufacturing, even more so in smart manufacturing, and reduces the scope for real self-sufficiency in manufacturing sectors, while at the same time increasing dependence on foreign value added. In a country that became the second largest economy in the world by integrating itself with most of it, self-sufficiency reminds of the bad old days of inward-oriented policies that headed to rather different and dismal results.
*The author would like to thank Corrado Molteni for comments and suggestions on a previous draft of this article.
The views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of the Italian Institute for International Political Studies (ISPI)