Jun 19, 2017 06:11 PM

Opinion: Chinese Manufacturing Needs Support, Not Smothering

The last few years have witnessed a resurgence in the popularity of “industrial policy” — the idea that national governments should direct the development of certain industries, especially in manufacturing. Germany has proposed its “Industry 4.0” plan; Britain’s prime minister promised to deliver “a proper industrial strategy” in the wake of the Brexit vote; and now the European Council has called for the EU “to provide a holistic EU industrial policy strategy” by 2018.

To a casual observer, the so-called China Manufacturing 2025 plan, or CM2025, resembles those of other large economies in aiming to improve domestic competitiveness. The government planners recognize not only that manufacturing is central to China’s economy, but also that global manufacturing is evolving. The plan talks about promoting innovation, developing talent and reducing pollution while ensuring a “decisive” role for the markets while continuing to open up.

However, China is not like other large economies, and when we look at the details of CM2025, we can see it is not like other industrial policies. Rather than simply facilitate bottom-up processes of research and development, protect the intellectual property of individuals, and allow the markets to dictate how innovations can be most productively employed, CM2025 takes a top-down approach of orchestrated innovation. It tries to pick the most important industries of the future — 10 of them — and even sets market share targets for them.

This kind of top-down approach to industrial policy is not a new phenomenon. In 1896, just a few months before he became president of the U.S., William McKinley said on the campaign trail: “The people of this country want an industrial policy that is for America and Americans.” He was defending a law that he wrote in 1890 that sharply increased the average tariffs on imports with the explicit goal of protecting specific domestic industries. However, although the economy grew quickly during this period, research shows that unprotected sectors grew faster and became more productive than protected industries, with the costs to consumers outweighing the benefits in even the most cosseted sectors.

Similarly, the policies to support China’s shift toward high-technology manufacturing run the risk of decreasing innovation and transferring inefficiencies to consumers, ultimately decreasing the likelihood that the policy succeeds. Limits on market access for foreign companies, forced technology transfers, and anti-competitive subsidies also might inspire protectionist policies in other countries that fear the political implications of sudden shifts in their own economies. This kind of response would ultimately make it harder for Chinese firms to compete globally and impose a huge cost on consumers in China that outweighs potential gains in the protected industries.

Essential to the success of CM2025 and the competitiveness of China’s economy is innovation, according to Premier Li Keqiang, and the largest barrier to innovation is lack of intellectual property protection, according to our members. But instead of protecting the fruits of innovation, CM2025 seems to encourage protecting industries from competition by picking domestic winners and supporting inefficient enterprises. During the last 30 years in China, innovation has been the highest where intervention has been the lowest. This outdated model of industrial policy creates a real risk that Chinese innovation will fall behind.

As Microsoft founder Bill Gates said: “Investing in R&D isn’t about the government picking winners and losers. The markets will do that.” If China wants more winners, implementation of CM2025 should focus more on deepening institutional reforms and less on trying to forecast an unpredictable future.

William Zarit is the chairman of the American Chamber of Commerce in China.

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