The secret sauce of Chinese industrial success
Smart state planning plus ferocious market competition
In standard western economic textbooks, state planning and market competition are mutually exclusive. Thatcher and Reagan brought western capitalism into the neoliberal phase by claiming “Government is not the answer. Government is the problem”, putting market fundamentalism on the altar. On the other side, Soviet central planning proved rigid and wasteful, leading to the eventual collapse of USSR.
Observing and learning from others’ development path, China went through three distinct economic models in the past 70+ years –
- 1949 – 1978, emulation of Soviet central planning phase, which provided the country a heavy industrial foundation but failed to deliver an adequate standard of living
- 1978 – 2012, free-wheeling laissez faire full-on capitalist phase, which saw rapid economic growth, rising standard of living but also wealth disparity, environmental degradation, and low value-added industrialization
- 2012 – now, mixed state planning and market competition phase, which is featured by state-led industrial upgrade programs, intense market-based competition, rapid improvement in industrial sophistication, and hopefully rise above middle-income trap to become the leading industrial powerhouse
The current model is antithetical to western mainstream economic theories but has led to clear success stories like the Made-in-China 2025 program (https://huabinoliver.substack.com/p/revisiting-made-in-china-2025-mic25).
I thought it would be interesting to discuss the features of this unique China model and the implications.
The two parts of this model – state planning and market competition – form an integrated approach to national economic development.
State planning incorporates these elements –
- Identify key industries to focus
- Set concrete and tangible targets (e.g. the 200+ goals set in MIC2025)
- Align policy support
The planning function is carried out by the China State Planning and Development Commission, which assembles the best minds in the government, academia, think tanks, and industries and goes through multi-year research, studies, and survey to understand and predict key technological trends and future market demand. Then they iterate and socialize the plans until there is broad buy-in.
Once top-line state planning priorities are set, central government empowers local governments to implement the policies. At the implementation level, fierce market competition becomes the norm.
Local governments compete with each other. Each local government is powerfully incentivized to create local tech and industrial champions as career advancements are typically tied in with achievements of national priorities.
Local governments will unleash suites of policy support measures to attract and help businesses succeed, including -
- Preferential tax
- Land use priority
- Preferential bank loans, even venture capital financing from government agencies (e.g. Shanghai and Shenzhen each has multi-billion dollar semiconductor funds)
Other policy support even extends to –
- Establish educational programs at universities to train and develop scientific and technical talents specifically for identified industries and technologies (e.g. AI, robotics, hypersonics, rare earth mining and refining, rail, ship building, etc.)
- Roll out talent acquisition programs to provide housing, allowances, and compensation equalization schemes to attract talents to move to their cities. Some governments even provide WeWork type of office facilities to startups for free.
- Invest in infrastructure upgrades including 5G coverage, EV charging stations, high speed rail, ports, bridges, etc. to enable smooth operation of large industrial enterprises.
- Invest in local parts and components supply chains that can be plugged into specific manufacturing sectors.
- Promote successful technical leaders and executives in critical industries into senior government positions (e.g. the head of AVIC, the leading aeronautic business in China, was promoted to become a provincial governor)
The central government went so far as to crack down on monopolistic consumer tech companies such as Alibaba and Tencent in 2019 as these companies were consuming too much financial and talent resources and preventing startups from emerging.
The main goal of the crackdown is to redirect resources (funding, talent) to more productive directions such as AI and hard tech.
As a result, in the key technological and industrial hubs across China, from Shanghai, Shenzhen, Wuhan, Chengdu to Hefei and Changsa, you will find hundreds of EV companies, solar energy companies, AI and robotics start ups, ship builders, and drone companies that are developing innovative technologies, building production capacity, and engage in intense competition for consumers.
In the competition, there are private businesses, state owned enterprises, and foreign companies as well. All have to compete for customers on price and quality and operate with razor thin margin. Innovation and cost efficiency are prized in the never-ending loop of hyper competition.
The Chinese industrial and technological ecosystem is often described by insiders as “arena for gladiators”. In a survival of the fittest environment, the winners of such competitions emerge as world class champions.
The same model is replicated in industry after industry from EV, smart phones, solar energy, robotics, ship building, AI large language models, drones, chip making, and biopharmaceuticals.
Many people mistakenly assume the Chinese state planning model means the government picks the winners and losers. That cannot be further from the truth. State planners pick the priority industries, define the swim lane, provide policy incentives, and then market takes over to decide the winner.
In contrast, the US industrial policy is more guilty of government picking winners – just witness how both Biden and Trump surround themselves with senior executives of incumbent tech giants when they announce policies such as the Chips Act, Inflation Reduction Act, or the Stargate program. Almost by definition, the main beneficiaries of these industrial policies will be the companies in the room. Market competition doesn’t seem to play the same decisive rule as in China.
As China accelerates the third mixed-economy phase of its industrial development, we can expect to see more Chinese companies will innovate faster, scale in the largest single market in the world, and become world-class competitors in their industries. Profit margins will be kept low as competition will never rest. However, more consumer surplus will accrue to customers, leading to improvement of living standards for all.
International bankers/investors run the Western system of "capitalism". Central banks control the money supply through a usurious debt-based economy - debt generation equates to an increase in money supply. Short-term shareholder profits are the engine driving business and the key to continued investor interest. Businesses operate under immense pressure to generate profits even at the cost of productivity, quality, damage to the environment, and pollution. Lobbying government for decreased "interference" such as reduced taxes, industry regulations, preferential taxation, etc., often result in reduced investment in infrastructure and inadequate environmental controls.
The system favours large corporations which swallow smaller businesses and are able to lobby government. The bankers and large corporations gain control of government, leaving behind the rest of the population and basically running the country to the benefit of the rich - over time a significant wealth divide occurs as the middle class undergoes significant shrinkage, the poor become poorer and social pressures increase. As these corporations grow in power they inhibit new entries to the market, thus in effect destroying the free market system they preach about.
The political system falls to the management of politicians who can most easily be bought by special interests and whose competence is limited to artful deceit, lies and obfuscations in support of their donor class who control them.
It doesn't matter what system a society uses as long as the laws of thermodynamics are observed. Society collapses because of the 2nd law of thermodynamics dynamic: the natural processes favor a state of greater disorder or randomness. It requires state control to maintain order. At the same time, the system must be flexible enough to handle unforeseen events. The West claims capitalism is the best yet it has not been applied to a society as big as China. We see in America, Europe and India, it can't handle very large population. The 2nd law of thermodynamics wins and society loses.
Nature requires something closer to China's system and not the USSR. The Chinese leaderships are engineers, and they understand systems and the laws of thermodynamics. We see how the local govts are given freedom to implement any policies they like as long as they fall within the guiding principles of the national government. They follow Field Marshal von Molkte's directive "no plan survive contact with the enemy". The Russian's system failed this principle.
We in the West refuse to admit it because of the racist Discovery Doctrine. It prevents us from facing the truth that capitalism must be put on a leash. Until we reject this doctrine, we will be stuck in the past.