China’s “Inevitable” Rise Through Protectionism

 

China’s rise as an economic power increasingly threatens the Asian and global geopolitical balance of power.  The growing realization in Washington that China’s ascent may be inevitable is based on the acknowledgement that Chinese policy makers are on a coherent and proven path of development, previously followed by the United States itself and later by Japan and the newly minted Asian tigers (Taiwan, South Korea, Hong Kong and Singapore). Japan and the Asian tigers were politically aligned with and militarily dependent on the United States and did not have the scale to upset the global order, but a resurgent China is a different matter.

The uniqueness of China’s rise cannot be over-emphasized. Every other country that has successfully broken out of the “middle-income trap” during the post-war period (the Asian tigers, Israel and today several eastern European countries) (China, the middle income trap and beyond) has done so with strong political, military and financial support from the United States. Most countries are not successful at building the institutions and executing the policies required to graduate beyond middle-income status, and many formerly “miracle economies,” face stagnation. Brazil is a case in point. Despite great natural resources and a vibrant entrepreneurial class, incoherent populist policies, an expansive state bureaucracy and oppressive taxes and regulations on business have caused stagnation since the early 1980’s. The result of Brazil’s stagnation at a time of great dynamism for China is an astonishing reversal in the relative importance of both countries to the global economy.

Source: World Bank

The Chinese model follows the well-worn protectionist path, embraced by the United States in the 19th century.  Once Great Britain had been well-established as the global hegemon, it espoused free-trade to facilitate the dissemination of its industrial production. The liberated Americans would have none of it. Alexander Hamilton’s Report on Manufacturers, submitted to Congress in 1791, which called for imports tariff and non-tariff barriers and subsidies for infant industries and innovation, provides a blueprint for the policies now followed by China. On the other hand, the U.S. as the new hegemon, has now assumed the role of the promoter of free trade.

China, with its huge market and high growth, has the same ability to attract capital and technology on its own terms that the U.S. had in the 19th Century. The Chinese have studied history and are simply following the path taken by the U.S. and the Asian Tigers. The Chinese know that to continue their rise they must now dominate high-value-added and technology-intensive industries, and they are determined to provide the protection and subsidies to facilitate this. In 2015, the government announced its Made in China 2025 and Internet Plus initiatives which aim to transform the country into a high-tech superpower by integrating artificial intelligence, robotics and social media. The plans are unabashedly protectionist and aim to substitute high tech imports by using the full regulatory and financial power of the state. This strategy of state supported industrial planning follows what Japan and Korea have assiduously done in the past, most recently with Korea’s full-fledged effort since 2001 to dominate robotics.

China’s plans have alarmed the world’s leading technology providers, such as the U.S., Japan, Germany and South Korea, and led to protests. President Trump last week signed an executive order asking his trade office to investigate China for theft of American technology and intellectual property.  But it is unlikely that China will change its path because it has history on its side and it believes that rival nations and corporations will cooperate to gain access to its markets. Moreover, there is no denying that the results of the policy so far are encouraging.

Many leading industries in the world today, from airplanes to internet search engines, have winner-take-all characteristics because of enormous capital intensity and/or network effects. China’s decision to restrict the freedom of American internet and ecommerce firms has promoted a vibrant domestic environment for tech start-ups unique in the world outside of Silicon Valley, and it has greatly facilitated the success of companies like Baidu, Tencent and Alibaba which are today the only global rivals to America’s tech hegemons.

The enormous amount of mobile phone and internet users, 751 million at last count, and the massive amounts of data they generate positions Chinese companies to become dominant players in the “internet of things,” artificial intelligence , data mining and related services. Neil Shen of Sequoia China, a leading venture capital investor in technology firms in China, succinctly states the bull case for the sector:

“I’m very optimistic about the prospects of the Artificial Intelligence industry in China, probably more so than back 20 years ago when china started with the online internet. The reasons being two: one is you need data for AI development and we have tons of data whether its Alibaba’s transaction data, social network data from Wechat, etc. And on top of that when you are looking at the researchers and experts in that space many are Chinese and if you are looking at quotations in research papers the Chinese AI research in the world has a very decent market share. And so, with that I think we have a very good chance to take a lead. In fact, fundamentally what is AI in the whole science field: its mathematics and statistics and China has very strong talent in these two areas.” Sequoia China’s Neil Shen (Bloomberg Interview).

China’s support of leading-edge practical technologies through subsidies, financing, R&D support, import protection and the leveraging of its huge market and the state’s purchasing power has led to significant breakthroughs. For example:

  • High-speed trains – Fuxing, the latest generation of Chinese bullet trains, with a maximum speed of 400 km/hour, was recently launched on the Shanghai-Beijing route, cutting travel time to 4 ½ hours. Fuxing is said to be 84% home-made standardized design, in contrast to previous generations which relied heavily on Japanese and French technology. The name, Fuxing, which means “revival,” is politically-loaded.(Caixin)
  • Over the past ten years, China has become the global leader in all aspects of the use and manufacturing of solar power. China is the world’s largest producer of photovoltaic power, and on track to add 40 gigawatts of capacity this year in its domestic market.
  • China also leads the world in the production and use of wind power and smart grid technologies.
  • China has become the global leader in the use and manufacturing of electric vehicles, selling 507,000 units in 2016, compared to 222,000 in Europe and 157,130 in the U.S.
  • China owns 70% of the world’s commercial drone market. For drones with communication-ability selling above $500/unit, Shenzen’s DJI is estimated to have around 70% of the U.S. market. DJI has become so dominant that competitors are abandoning hardware manufacturing to focus on software applications exclusively. Chinese military drones, with similar range and effectiveness as the U.S. military’s Predator and Reaper drones but selling at a fraction of the cost, have been gaining significant foreign market share, at the expense of the U.S. (WSJ).
  • Surveillance technology – Shenzen’s Hikvision, a subsidiary of CETC, a state conglomerate with close ties to the military, has become a global leader in internet-based digital surveillance systems which are being widely deployed in China and other countries through CCTV, ATMs and mobile phone applications. The company has become a leader in facial recognition and data harvesting.
  • Facial recognition – Beijing-based Megvii’s Face++ is the world’s largest face-recognition technology platform, currently used by more than 300,000 developers in 150 countries to identify faces, images, text and documents, such as government IDs. Baidu and SenseTime are also important players in this space.
  • Mobile Telephony – Chinese firms control over half the global market for mobile phones, with growing domination in emerging markets. China aims to be a leader in 5G mobile networks, and plans to spend $250 billion to have an operative system over the next five years.
  • Quantum Telecommunications – China appears to have the lead in the development of the new technology, “hackproof” quantum communications . China is said to be near completion of a 2,000 km “unhackable” fiber network linking Shanghai and Beijing. Moreover, Chinese researchers recently announced a breakthrough in successfully teleporting “entangled” photons from a quantum satellite 480 km above the earth to two terrestrial stations 1,200 km apart, and the government plans the deployment of a fleet of quantum-enabled satellites linking China nationwide and with Asia and Europe by 2020. The idea is to control a Chinese-centric hack-proof, cybersecure global network.

There are two new priority areas were the Chinese state is committed to deploying its financial and protectionist might:

  • Semiconductors – China has made it a national security priority to control the semiconductor supply chain. The government is lavishing money on the country’s chip makers, including $22 billion on state-owned Tsinghua Unigroup. Some 20 fabs are currently under construction in China. (WSJ)
  • Artificial Intelligence – China’s State Council in June announced a plan to provide tax benefits and state support to make China a global leader in AI by 2025 and Chinese companies major players in self-driving cars, smart robotics, wearable devices and virtual reality.

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