China Industrial Policy Process — Giorgio Prodi, Osservatorio Asia Scientific Committee

Introduction:
China’s tremendous economic growth is the result of the shifts in its economic system. However, the country’s transition from a strictly planned economy to a market economy — or as is written in the Chinese constitution, a “Socialist Market Economy” — has been strongly steered by the Government itself. While Europe and the Usa were ready to reduce the role of their industrial policies, China did not hesitate to use all its tools: sectorial and horizontal policies, export subsidies, help for local development, restructuring state-owned companies, investment for infrastructures, etc. China’s growth model was based, in order, on investment and export. On total GDP, investment accounted more than 40% in some years. Japan, another successful case in Asia, had the same percentage barely reaching 30%. Exports too are crucial for China, but the same experience has been shared by other countries. Japan and Germany registered huge trade surplus for many years (and still today). In the case of China, the export’s weight on GDP does not necessarily mean an “export led growth”. Imports and value added due to export are to be taken into consideration, too. Several studies confirm that export’s contribution to Chinese growth is equal to approximately ⅓ of it, an important share but not the majority[1].
History:
China’s economic evolution towards a free-market system can be broken up into three main phases.
The first is the decade ranging from 1978 to 1989 stemming from the country’s Open Door Policy, which started China’s entrance into the global market. In these years the focus was on the creation of market players. During this time, the government did not need to indicate because these were already included in the country’s original planned economy.
Eventually, China’s traditional economic system began gradually working alongside an emerging market economy. The protagonists of the new scene were mainly businesses owned by Chinese municipalities, known as Town and Village Enterprises. (TVE ) generally operated in labour intensive industries to exploit the cheap and abundant workforce. In the early 1990s the TVE made up 50% of the country’s industrial production, and more than ⅓ of all exports. Also State Owned Enterprises (SOEs) were allowed to produce for the market only once they had met the requirements defined by the five-year-plans. They were not privatized (an infant capital market could not underpin the process) but restructured.
The government then began to authorize the establishment of local private sectors and that of foreign companies into China. Overseas collaboration initially took the form of joint ventures, but then Wholly owned foreign enterprises (WOFEs ) were allowed. In this period, the industrial policies are aimed to build a market, by creating companies, attracting technologies and capitals from abroad.
In 1979, Specific Economic Zones were introduced with this purposes, and to delineate the areas where new economic policies would be implemented (in the hope that, if they were successful, they would expand onto other areas). SEZs later became essentially open to Chinese companies as well, so that they would come into direct contact with the free-market system. The attraction of foreign capitals, however, was not crucial for China’s development, despite the important incentives that came with it (several years of tax reliefs, no import duties, improved infrastructure, and fewer administrative constraints). This was because the companies that operated in the SEZs were forced to re-export their entire production, and because industrial policies were still vague enough to allow for widespread corruption. So, that was a period with prudent reforms, sensitive to the danger of leave somebody behind (reforms without losers[2]).
Throughout the 1990s, China took yet another leap forward into the modern market under Zhu Rongji’s leadership. Two main events marked the period with progress: the de facto closure of the country’s planned economy (despite its five-year-plan stamp), and the increase of financial resources used for business incentives (thanks to China’s boom in the previous decade). That was also the time frame in which the market economy was already well underway and looking to recruit its local and global players, through a “reform with losers” maneuver. The most significant element of China’s shift in economic policies was when it restructured its SOEs. Greater employment in private sectors allowed for more thorough reforms in the public ones. During the mid-1990’s SOEs accounted for 120,000 units, compared to a mere 35,000 today[3]. Still, it is vital to understand that China’s path to economic success was not due to its privatization process alone; instead, it found profit by merging companies, and shutting the less efficient ones down entirely. What stands out is that the government did not have to back down in order for the economy to flourish. In fact, the Public Service sector actually witnessed an increase in personnel over the decade.
Business incentives were created to draw foreign companies, which were gradually allowed to compete on the local market as well. SEZs multiplied as a result of the competition among the Provinces that eventually granted the same privileges also to other areas outside SEZs. Reforming SEZs, and managing relations between local and foreign firms on the emerging markets was joined by new economic policies. These ranged from price control for a variety of goods (primarily energy), to financing large infrastructures in order to to support infant industries. The establishment of new industrial policies at the time paved the way for a fast-developing economy, based on investments and export.
This second phase actually ends with China’s entry into the WTO in December, 2001, as well as President Hu Jintao’s and Prime Minister Wen Jiaobao’s joined leadership in 2003. From an economic perspective, China’s progress during the decade overlapping the turn of the century — and at a time when the free-market economies were gaining international importance — is tremendous. But it is also true that the country’s industrial policies were inevitably headed in that direction in order to “digest” reforms passed under Zhu Rongji. The most important achievement is the creation of a national holding for all the SOEs.
Furthermore, joining the WTO implied that the government would be forced to use less intrusive policies on one hand (price control), and to repeal restrictive ones on the other (import duties or quotas). It is the time span that marks China with its socialist market economy stamp, which, according to the CCP, is a system where the market is important, but only in light of socio-economic development. Moreover, and perhaps more importantly, it is a system defined and directed by the government. Both the State and the market are equally necessary for this economic model to effectively work.
Industrial Policies
Aside from the reforms on SOEs previously mentioned, there are numerous other policies that today play an important role for the development of China’s economy. Foreign direct investment (FDI) attraction policies are among these. Today, foreign companies make up 10% of China’s non-agricultural workforce (more than 25 million people), 60% of national export, and a significant number of imports, too. Foreign firms are also more capital intensive, as well as more technologically advanced, enabling them to contribute to China’s qualitative and quantitative development.
Sectorial policies also play an important role today, even if less of what they did in the past. The government categorizes areas in China’s economy that need to be privileged during growth, updated or restored, those that need to be abandoned, or those that overproduce. These sectors are subject to change over time or throughout geographic areas.
Among these, prioritized sectors are generally granted better access to credit, provided with construction areas for factories, and supported for import and export necessities. Foreign firms’ access to China’s sectorial politics is expected to vary according to poli-economic preferences. In some sectors, foreign presence is encouraged (specifically those regarding high-technology), while in those that the government reputes less important it is allowed, though not necessarily called for. In other sectors still, outside cooperation is accepted for strategic purposes such as finance, but only in partnership with local companies. Finally, there are more sensitive fields where foreign assistance is not authorized at all; these may include the national defense, and the production and distribution of energy, etc. .
The government stretches its support to both public and private companies. It seems as though China favors the growth of national champions, able to compete on the global market. The most notable example is, perhaps, Huawei. Huawei is a private Chinese firm that specializes in telecommunications, and that has become extremely successful because of its reliance on the central government. The State provided Huawei with substantial funds, and even helped it earn contracts on Asian and African markets, which brought it to reach the status it currently enjoys. Today, Huawei is a global leader in its sector, as it provides the most important telecommunication enterprises — worldwide — with its network devices.
Even China’s Public Procurement system is structured so as to favor industrial national growth. We have to remember that China still misses its adhesion to the WTO Multilateral Agreement on Public Procurement. In fact, it is generally expected that public tenders opt for locally developed technologies (which legally can be up to 8% more expensive than foreign ones). Yet another quota is reserved for small and medium-sized enterprises (SMEs) which are predominantly Chinese[4]. But this is not a strictly Chinese prerogative. The United States privileges national prosperity in much a similar way, as seen since the “Buy American Act” of 1933.
Innovation policies are another fundamental aspect to China’s industrialization. In the first part of the country’s openness and development, foreign technologies prevailed in the forms of import or direct investment. Yet, in recent years, China’s Research and Development investments have consistently increased — through university and entrepreneurial efforts — rendering it one of the leading countries in the sector. National plans have started to emerge alongside provincial ones in the search for bright minds and top technologies. Competition between provinces of course increases the risk of duplications. The main focus is set towards projects that may influence several sectors, e.g. nanotechnology, or to the development of specific project, like a medium-range commercial jet plane.
Finally, there are projects that look towards upgrading already-established industries, like those of textile and clothing[5]. Policies’ potential limits derive from the lack of cohesion towards intellectual property rights which, in turn, discourage innovative processes. It is important to underline that this latter obstacle affects foreign and Chinese companies equally.
The government’s ability to direct these policies laysalsoupon law enforcement. For instance, Chinese environmental law is substantially in line with other developed nations. What is missing is the implementation of these laws. If the government and its sub-offices were to move a polluting industry to another location within the country, it could apply the same policies in a more restrictive manner in a place and in a less restrictive in another.
After joining the WTO, China’s main obstacle is to keep a social cohesion, while driving its economic progress on an internal market model, as opposed to the one based strictly on export. And industrial policies seek to deal with these very objectives.
When introduced, industrial policies were directed towards two main development strategies: “go west” and “go global”. The first refers to local and, specifically, provincial development. The other involves a system based on a global supply of raw materials and exports, so as to make China a more important actor on the international market. The China Development Bank, for example, gave out loans to foreign entities asking for basic commodities and energy resources in return.
China’s domestic market grew so much that incentives for foreign companies could be reduced in order to foster and privilegiate new technologies instead. In fact, the size of China’s domestic development is exactly what benefits the government, consistently, by putting it in an increasingly powerful position. In order to be included by Chinese Airlines, both Boeing and Airbus accepted moving part of their aircraft assembly to the country itself.
Perhaps the most interesting aspect of Chinese industrial policies is that not only they are used as a tool for economic growth, but they are also deeply rooted in the process of national development and reform. In regards, the 2007 Antitrust Law is enlightening. The statute not only covers all the antitrust legalities presented in Western countries — predatory pricing, abuse of dominant position, cartels, merges and acquisitions — but promises “To promote the healthy development of the socialist market economy”. This regulation does not apply for SOEs in strategic sectors, and allows for cartels among them. It has been used in different cases so as to limit multinationals’ admission, even in instances where market shares from potential acquisitions were relatively low.
Not all industrial policies fulfilled their expectations, however. The automotive sector, for example, was successful in attracting all the main international producers in the field, but failed (till now) to create a national company to compete on the global market. The upside is that, as of today, China is the country where the enterprises have the biggest State help in the world.
Who manages industrial policies?
Industrial policies are defined at the central level by the State Council. Within the Council, the National Development and Reform Commission plays a central role in drawing out these duties. The NDRC is an internal branch established in 2003 that mutated from the former-State Planning Commission; during the 1950s, the latter was in charge of drawing out the five-year-plans. Now, the NDRC strategizes long-term development projects, on both macro and micro levels, and has the power to decide upon the most important investments, whether local or foreign (from infrastructure to energy plans). It is also in charge of all industrial restructuring. The NDRC is among the highest ranking governmental entities — more powerful than single ministers — and is often dubbed the Small State Council due its position. Recently, the NDRC has passed some of its tasks to be managed by the Ministry of Industry and Information Technology (MIIT), but it still remains absolutely sovereign.
Another very important role is played by the State-owned Assets Supervision and Administration Commission (SASAC). Founded in 2003, this ownership agency controls public companies in the areas where the government would like to keep a substantial monopoly; from the military to telecommunications, oil, electricity, carbon, overseas shipping, and airlines. SASAC also manages holdings in more competitive sectors and, because it is under direct governmental control, its president actually enjoys a minister ranking as well. The Commission is a sort of hybrid because supervises and manages companies. In practice, however, many of the firms operated by the SASAC are, in reality, so large to be highly autonomous (such as Petro China). Company leaders are directly appointed by the State to which they report. At times, there can be strong competition among companies within SASAC governed enterprises, which is usually based on a power tug-of-war, and does not imply necessarily lower prices or greater work efficiency. For example, Air China has recently made an agreement with Hong Kong’s Cathay Pacific, and was able thanks to political support to stop China Eastern (also a member of SASAC) to do the same with Singapore Airlines[6]; the agreement would have introduced a new competitive candidate, and it would have also bettered services on the local market.
SASAC’s noteworthiness in managing public companies can be seen through national statistics. These firms: employ more than 8 million people, represent one fourth of the government’s tax revenue, make up one third of the country’s industrial production, and contribute to 80% of market capitalization on Shanghai’s stock exchange. Figures show that, through the government, SASAC has a strong impact on China’s industrial policies. A primary example is when in 2008, before the economic crisis, gas prices reached a soaring $140 per barrel, and the government prevented local gas prices to increase accordingly. In 2009, a new economic mechanism was introduced by which gas prices for the customer is now linked to the barrel’s cost. Still, in cases where prices would shoot up, gas would go up but less than proportionally. SASAC’ needs to ensure employment in areas where the private entrepreneurship is still less dynamic.
In keeping under governmental authority, policy banks also shape a large part of China’s industrial direction. The China Development Bank and the China Exim Bank are important actors among the financial arena. The CDB is in charge of financing large, domestic projects albeit its growing involvement in foreign infrastructure. Instead, CEIB specializes in activities within China’s import and export system, as well as — but to a lesser degree than CDB— infrastructural investment. In any case, the Chinese banking system is, itself, controlled by the State, and therefore responds directly to its authority.
China’s stimulus package, introduced to overcome the global economic crisis, was implemented more quickly than in the United States’, because of its governmental background. This does not go as far as to suggest that industrial policies deserve monolithic management. In reality, many of these policies need to be enforced at either a provincial or lower level, as they are part of the relationship between competition and cooperation in an array of the State’s decision-making process. Historically, Provinces used to have a high level of autonomy; today, both NDRC and SASAC have provincial branches. Yet, there is not always a perfect understanding between these entities, such as the way in which many ministers see NDRC’s role — themselves working towards greater autonomy instead.
Concluding remarks
Policies and political actors clearly express their common steady move towards investments. Facilitated access to credit, and greater incentives for pillar industries encourage investments, like attraction policies for FDIs. SOEs’ profits can be almost entirely retained, to become ulterior investments.
In addition, state managers, and administrators that plan infrastructural projects, are more often valued for their investments as opposed to their efficiency and competence.
In fact, managers and administrators are often evaluated (sometimes promoted) and sent to work in other geographical areas (sometimes remote) before their investments are fully implemented. Even if the investments prove to be unnecessary or unprofitable, the chances that the proposer will be punished are slim. Lastly, competition between and within provinces unleash a race towards investments. The central government tries to avoid for investment projects to overlap, but, taking all together, the effect is a strong support for investments.
Again, China’s stimulus package was presented as a series of measures aimed at increasing consumption by strengthening of the welfare state (health, education and pensions), but, for the most part, is based on infrastructural investment. State Owned firms are the first to benefit from these operations, as they dominate network industries to the point that they have now acquired more political (and also economic) power.
The twelfth five-year-plan, from 2011 to 2015 raises new challenges for China’s development, and thus, for its industrial system as well. It is most certainly an ambitious plan, as it seeks to reach a 7% yearly growth rate — which is considerably high, despite the country’s previous growth figures — while diminishing the gap between the rich and the poor, both socially and geographically.
The latter approach favors a greater development of the welfare state system, which is currently a source of dissent upon China’s population. Altogether, these changes can only really take place with an economic model that expands beyond investment and export; they are thus not part of a new redistribution plan, but of a larger, more complex development model.
It is especially hard to understand where this five-year-plan might be headed, because halfway through its establishment, in 2013, China will entirely change its leadership. Surely, even within the government, the industrial debate is present, alive, and not to be underestimated.
In order to change China’s development model, the framework behind its incentive policies must also change, which implies that the balance of power within the country’s industries must change accordingly. These shifts, however, are not limited to industrial politics alone. They are also part of a the social sphere, where the country should steer towards a better welfare state system, allowing for its citizens to save less for health, school, and pension and consume more. Still industries and firms come back into play. The SOEs have the resources for this transition to take shape. It is therefore necessary for state enterprises to give more of their profits to the State’s shareholders; today that sum amounts to an average of less than 10%.
It is also likely that private companies might have to pay higher tax revenue to the State as well. Also, greater priority should be set on following fiscal rules more so than on setting rates, which have been recently ranked equal to those of foreign enterprises in the country. These are, undoubtedly, significant changes. On one hand, they call for the reduction of power and discretion from SOEs. On the other, they envisage a change for the non-written agreement between the government and entrepreneurs, a tacit accord giving political power to the former and economic freedom to the latter.
As Barry Naughton[7] wrote, in a scenario like China’s, public property can be reasonably efficient, but what is more important is competition than the ownership itself. It will be interesting to see how the government will, de facto, abandon the investment-based development strategy that has brought the country forward for so many years.
This mechanism was actually delineated even before it became an obvious concern in the recent NPCC’s plenary meetings. But in practice, policies like the last stimulus package, or the value added tax reform — which allowed the companies to deduct from income taxation their investments as if they were ordinary production inputs — push for more investments. And changing an economic strategy which still proves to be successful is not a politically simple task.
Overall, it seems as though governmental influence on economic issues will not diminish anytime soon and this has to be considered also by countries where public intervention is seen through a skeptical lens. After all, if one of the first global competitors uses industrial policies as an instrument for growth, it is inevitable to have repercussions on the rest of the world.
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[1]D. He, W. Zhang, How dependent is the Chinese economy on exports and in what sense has its growth been export-led?, Journal of Asian Economics (2009),
[2]Lau, L, Qian, Y. and G. Roland (2001), “Reforms Without Losers: An Interpretation of china’s Dual – Track Approach to Transition,” Journal of Political Economy, 108(1), 120-143.
[3]Weiye Lie LouisPutterman, “Reforming China’s SOEs: An Overview” Comparative Economic Studies, 2008, 50, (353–380)
[4]Ping Wang “Public Procurement in China A Long March Towards Integration into the Global Trading System”, Routledge,2010
[5]Sylvia SchwaagSerger& Magnus Breidne“China’s Fifteen-Year Plan for Scienceand Technology: An Assessment”, Asia policy, number 4 (july 2007), 135–164. Oecd Review of Innovation Policy, Oecd, 2008
[6] See Barry Naughton, “SASAC and Rising Corporate Power in China”China Leadership Monitor, No. 24 2008 [7]Naughton, Barry Naughton “China’s Distinctive System: can it be a model for others?”, Journal of Contemporary China, 19: 65, 437 – 460, 2010. Questa posizione non è tuttavia universalmente condivisa. Per una vision alternativa si veda Derek Scissors,“Dendundone”, ForeignAffarsMay/June 2009.