What’s Next for China’s Economy and What Does it Have to Do with Trump’s Trade War?

Posted by

The “Made in China 2025” program has made headlines in the United States, especially in connection with President Trump’s recent trade disputes with China. Although media coverage of it increased in 2018, the program took effect in 2015. Made in China 2025, as its name suggests, aims to augment China’s manufacturing capacity, especially  shifting China’s economy from low-tech industries to cutting-edge innovation and research to support advanced manufacturing. While many US government officials have expressed concern about the program it may be unclear to stakeholders how Made in China 2025 intends to achieve its goals.

Chinese Premier Li Keqiang announced the Made in China 2025 program in May 2015 and it has since become his key policy initiative. Although China’s economy continues to grow rapidly, it has not yet shifted from lower-tech manufacturing of goods like telephones and car parts to high-tech products like jet engines and medical devices. This creates a situation in which China could be outcompeted both by lower-cost manufacturers of low-tech goods and more technologically advanced developed countries on the other hand. This phenomenon has occurred in other countries and is referred to by economists as the “middle-income trap.” Made in China 2025 aims to avoid the middle-income trap by advancing China’s economy until it is competitive with developed countries in the following key advanced manufacturing industries:

  • Advanced information technology
  • Automation and robotics
  • Aerospace
  • Maritime and high-tech shipping
  • Railroad and trains
  • Alternative-fuel vehicles
  • Electrical equipment
  • Agricultural machinery
  • Advanced materials
  • Medicine and pharmaceuticals

China either lacks significant manufacturing capacity in these industries, does not produce the elementary pieces of these final products, or builds these products with designs from other countries. As such, Made in China 2025 intends to grow domestic innovation, expand manufacturing, and build local supply chains.

Perhaps the most important aspect of Made in China 2025, and what makes it so controversial in the United States, is the way that Chinese policymakers plan to achieve these goals. China’s government, and particularly its military, controls a significant part of the country’s economy. According to the U.S. State Department, state-owned enterprises account for 30 to 40% of China’s GDP and employ about a fifth of the country’s workers. This level of government involvement allows for policymakers to act in ways other countries cannot, as free-market economies allow for less control from a central government. Particularly, the state can invest in research and innovation through state-owned enterprises and through the government itself.

However, Made in China 2025 also constitutes a significant shift away from the country’s state-capitalist roots.The program calls on the government to strengthen free markets and protections for business. This includes two key policies of establishing manufacturing innovation centers (with 15 by 2020 and 40 by 2025) and strengthening intellectual property protections.

Policymakers believe these policies will support and increase private-sector innovation. Manufacturing innovation centers will directly support new technology by funding research, and strengthened intellectual property rights will allow businesses to receive more benefits from their  discoveries, thus incentivizing research.

While these policies are important, state-owned enterprises and the Export-Import Bank of China have the ability to support Made in China 2025 without changes in policy. These efforts have already attracted resistance from policymakers in the United States and Europe. Chinese technology companies have acquired intellectual property from US and European manufacturers through technology transfers, buyouts, and alleged industrial espionage. Although none of these efforts constitute the indigenous Chinese innovation that Made in China 2025 aims to grow, they are ways for Chinese companies to support their own innovation and improve products in advanced manufacturing sectors. As such, actions by Chinese tech companies such as Huawei and ZTE have come under increasing scrutiny over the past several years.

America’s Reaction

American policymakers have pushed back against Made in China 2025. Although international trade agreements, like the World Trade Organization’s rules, do not prohibit countries from supporting domestic manufacturers, the program has received suspicion both because of allegations of industrial espionage and because of  more fundamental concerns about geopolitical competition between the United States and China, as noted by the Trump Administration’s National Security Strategy. So far, American policymakers have targeted China’s investments and its exports with new scrutiny and proposed tariffs.The Committee of Foreign Investment in the United States (CFIUS) reviews, as its name suggests, foreign (including Chinese) investment in the United States, including mergers between and acquisitions of strategically-important American businesses. CFIUS was reformed by the Foreign Investment Risk Review Modernization Act of 2018 (FIRRMA) in response to concerns about Chinese firms’ technology transfers.

CFIUS members include the Secretaries of the Treasury, Commerce, Energy, Defense, Homeland Security, and State, and the Attorney General, U.S. Trade Representative and White House Director of Science and Technology Policy. The Trump Administration has used CFIUS to counter buyouts of American companies in advanced industries, as it did when Broadcom attempted a hostile takeover of Qualcomm, a US-based telecommunication equipment designer.  Although proponents argue that it will protect strategically important technologies, enhanced CFIUS scrutiny could make it harder for US businesses to attract investment from abroad.

Although President Trump’s proposed tariffs have targeted goods from far more countries than China, the administration directly levied tariffs on some Chinese goods protected by Made in China 2025. Through an investigation pursuant to Section 301 of the Trade Act of 1974, the office of the U.S. Trade Representative (USTR) declared that China’s policies, including “Made in China 2025” unfairly favor Chinese industry, and released a list of tariffs designed to punish China and level the playing field. When USTR released the list of goods that would receive tariffs, observers noted that many of the goods are not currently central to the Chinese economy. However, many of the tariffed goods are in sectors prioritized by Made in China 2025, such as industrial robotics. In theory, these tariffs will counter the program by disadvantaging targeted products in the international market. On one hand, the tariffs will undermine Chinese industry and protect American manufacturers from competition. On the other hand, increased competition could lower the prices of advanced manufacturing products and make them more accessible to the businesses which would buy them, especially consumers or small- and medium-sized companies which may not otherwise be able to afford products such as solar panels or industrial automation.

Outlook

Made in China 2025’s success is dependent on whether US responses will be sustained and successful. US business leaders and policymakers from both party have sharply criticized President Trump’s tariffs, although they have been more supportive of a reformed CFIUS. Pressure may mount for President Trump to drop protectionist trade policies and allow increased competition despite national security concerns. Of course the program could fail on its own. Some Chinese policymakers have argued that the program does not go far enough in terms of boosting research spending, and simply spending without making more wide-ranging changes to its economic model may not work. Furthermore, if China has to borrow money to do so, increased spending could compound the already-significant amount of debt in the Chinese economy, which some observers have said could lead to economic problems in the long-run. China’s economic transformation over the last 40 years has been unprecedented: Made in China 2025 could be part of further transformation, but it will certainly receive more pushback from global policymakers than previous Chinese reform.

 

To learn more about US reactions to Made in China 2025, download National Journal Presentation Center’s CFIUS Primer.

Please follow and like us: