China’s drive for industrial dominance is likely to hurt developing countries – and itself

Economic policymakers see a pivot towards investment in ‘new productive forces’ as necessary if China is to become a ‘medium-level developed country’
But if Chinese workers were to make less and buy more, other countries could grow faster and so buy more advanced manufactured goods from China

Donald LowandDavid Skilling

Published: 11:00am, 24 Mar 2024

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The main takeaway from the recently concluded “two sessions” in Beijing is that China is intent on achieving dominance and technological parity (if not leadership) in a wide range of industries. The Chinese leadership clearly believes that boosting investments in what it calls “new productive forces” is how China will achieve growth of around 5 per cent in 2024 and beyond. But is this strategy the correct one for China? And is it desirable for other countries, especially developing ones that are looking to export-led industrialisation to sustain growth?

The first thing to emphasise about the Chinese economy is that investment as a share of its gross domestic product is already very high. Correspondingly, consumption as a share of GDP is unusually low. Compared to a global average of about 70 per cent, consumption is just over 50 per cent of GDP in China. A low consumption share also means that China’s savings, at more than 40 per cent of GDP, are by far the highest among major economies.

By definition, a country’s savings must equal its investments and net exports if demand is to equal potential supply. If savings exceed investments and net exports, the economy is likely to suffer stagnation (and deflation) as balance is restored. This is already happening in China to some extent. Conversely, if domestic savings fall short of investments and net exports, it is likely to experience accelerating inflation, increasing foreign debt, and a worsening trade deficit.

China’s leaders attend a meeting of the 14th National People’s Congress, part of the two sessions, at the Great Hall of the People in Beijing this month. Photo: Xinhua

The second salient fact about the Chinese economy is that the real estate sector has been the dominant form of investment over the last decade or so. The end of the property bubble means that China’s investment rate should come down, allowing the savings rate to fall. But the savings rate has remained stubbornly high, with weak consumption growth since the end of the zero-Covid policy. The longer-term reason for the low share of consumption is that China’s social-security system is underdeveloped, causing more precautionary savings by households than in advanced economies.

Economic policymakers in China see the pivot away from investment in property to investment in “new productive forces” as necessary if China is to become a “medium-level developed country” of about US$26,000 in GDP per capita (or twice the current level) by 2035. This would require annual GDP growth of about 6 per cent for the next decade or so.

But it is not clear that maintaining investment at the current share of GDP is desirable. An unusually high investment rate made a lot of sense when China’s population was young, the workforce was increasing, and the country’s infrastructure and productive capacity were underdeveloped. None of these is true any more. Additional investments are likely to yield diminishing returns; they have also been associated with higher levels of indebtedness (by firms, local governments and households) and wasteful spending.

Photovoltaic panels at a solar plant on the outskirts of Beijing. Can the advent of renewable-energy technologies justify maintaining investment at the current percentage of GDP? Photo: Bloomberg

What about the argument that the advent of new technologies such as artificial intelligence and green technologies and the need for renewable energy infrastructure justify maintaining investment at the current percentage of GDP? There is clearly an argument for investment-switching; replacing wasteful investments in property with investments in these new technologies and infrastructure makes sense.

But for China to avoid overcapacity in the new areas now prioritised for investment, there must be sufficient final demand – whether from domestic consumers or foreign ones – for the new advanced manufactured goods. If Chinese consumption remains low – and there is little to indicate that Chinese policymakers want to boost consumption in the near term – who will absorb China’s greater productive capacity?

Since a country’s savings-investment gap is also the trade balance, another way of asking the question is who will run the trade deficits large enough to offset the trade surpluses (or excess savings) that China is likely to continue running? China’s trade surplus is 5 per cent of GDP; in manufacturing, it is even higher at around 10 per cent, or nearly 2 per cent of global GDP.

A container ship at the Port of Los Angeles in California. The US is pursuing industrial policies to reduce its reliance on advanced Chinese imports. Photo: Bloomberg

For most of the first decade of the 21st century, the answer was the United States. Then, the US’ trade deficit was the mirror of China’s massive trade surplus. And the global savings glut (mostly from China) financed US consumption by buying US government securities. This kept US interest rates low, and contributed to a consumption and housing boom that culminated in the global financial crisis.

Today, the US is much less willing to tolerate such global imbalances. The US is also pursuing industrial policies to reduce its reliance on imports of advanced manufactured goods from China. While its overall merchandise trade deficit has remained constant at around 3 per cent of GDP, the US’ trade deficit with China fell by about 20 per cent in 2023. The same can be said of Europe and the rest of the developed world. Post-Covid, most developed countries have started, or stepped up, efforts to de-risk and reduce their reliance on China-centred supply chains.

That leaves developing countries as the more likely candidate to absorb China’s trade surplus. But large developing countries – such as India, Vietnam and Bangladesh – are either already pursuing export-led industrialisation or want to do so. They are unlikely to acquiesce in the face of rising trade deficits with China, especially if these are seen as hurting their efforts to develop competitiveness in manufacturing.

Workers assemble Vinfast electric cars at a factory in Hai Phong, Vietnam, last year. A number of developing Asian countries are already pursuing export-led industrialisation of their own. Photo: AP

Unless China practises a far narrower, more selective form of industrial targeting that does not try to retain traditional industries, but allows them to migrate to other developing countries, one would expect these countries to respond to Chinese competitive pressures by erecting trade barriers of their own. In the near term, exports of Chinese overcapacity would already generate significant competitive stresses.

Among upper-middle-income developing countries, many have the ambition (and ability) to become competitive in parts of the advanced manufacturing value chain that China now prioritises. Malaysia, for instance, is already the world’s sixth-largest exporter of semiconductors, and packages 23 per cent of all American chips – thanks largely to investments by American and European companies. Turkey has emerged as an important tech and semiconductor producer for non-EU states in Europe.

Who’s left? Mainly commodity exporters (such as Indonesia, Brazil, Saudi Arabia) and poorer developing countries reliant on foreign loans to finance their trade deficits. It should be clear why a collection of these countries cannot be a significant part of the offsetting trade deficits to China’s trade surplus: their economies are simply not large enough. Through the Belt and Road Initiative, China could increase lending to these countries to absorb its excess savings. But such loans are likely to go bad if these countries run into balance-of-payments crises.

China’s plan for ‘new productive forces’ should make the West sit up

The sensible course is for China’s policymakers to accept that investment as a share of GDP must fall, even as it promotes investment in new areas. Industrial policy should be pursued in a much more selective and targeted fashion to avoid overcapacity. If Chinese workers were to make fewer clothes, plastic goods and cheap electronics, and bought more of them from other countries instead, this would allow other developing countries to grow faster and so buy more solar panels, electric vehicles, and other advanced manufactured goods from China.

The best way the authorities can catalyse this restructuring – one that is beneficial for China and the developing world – is to boost consumption spending. In the short term, this would entail cash transfers to households (rather than more infrastructure spending); in the medium term, the Chinese state should spend considerably more on social security so that households have the confidence to open their (digital) wallets. A failure to do so will mean distortions, higher costs, and weaker growth in China – and across the global economy.

Donald Low is senior lecturer and professor of practice in public policy at the Hong Kong University of Science and Technology. David Skilling is the founding director of the Landfall Strategy Group