Weekend Long Read: As China Exhausts Low-Cost Advantage, Urgent Shift to Innovation Needed

China is entering a new stage in its economic development where low-cost production is no longer advantageous, and both exports and inward foreign direct investment (FDI) are encountering difficulties. Additionally, the country faces the significant challenge of an aging population [para. 1].

To sustain growth, China must pivot towards a new economic model focused on innovation, digital technology, and the domestic market. The core transition is from growth driven by low-cost advantages to growth driven by innovation [para. 2][para. 3].

Harvard Business School professor Michael E. Porter identified key factors influencing innovation efficiency, such as a country’s level of openness and the vitality of the private sector [para. 5][para. 7]. In a complex international environment, maintaining openness is crucial for innovation. For instance, if China cuts off interactions with countries that control most advanced technologies, it could hinder scientific and technological progress [para. 6]. Ensuring the private sector thrives is also critical for sustaining innovation, and boosting confidence among entrepreneurs remains a pressing challenge [para. 9].

Technological innovation has driven the development of the “new three” — electric vehicles, lithium-ion batteries, and solar cells — and their exports have gained international attention. However, U.S. Treasury Secretary Janet Yellen suggested that China’s excess capacity might disrupt international trade and impact U.S. industry and employment, an indication of China’s growing competitiveness in certain areas [para. 11][para. 12]. Historically, China’s exports of excess products did not provoke much reaction, but escalating geopolitical tensions and the increased size of the Chinese economy have made the issue more complex [para. 15][para. 17][para. 18].

Despite advancements in the “new three,” China’s innovations remain limited. The country should have a broader array of innovations given its size and stage of development. Policymakers should focus on overcoming technological bottlenecks rather than merely replicating existing products. However, local governments often support new-energy products even if they are not performing well, which is problematic [para. 21][para. 23].

Addressing macroeconomic imbalances is crucial for China to avoid persistent overcapacity. Balancing investment and consumption is essential, as excessive consumption without investment or excessive investment without consumption can hinder economic growth. While recent policies have supported consumption, the impact may be limited if consumers are already cutting back on spending. The government should consider increasing spending directly through enhanced social security, improved benefits for urban residents, or direct cash transfers [para. 24][para. 27][para. 29]. Despite opposition, direct financial aid can boost aggregate demand, leading to increased orders, production, employment, and potential economic growth [para. 28].

Completely eliminating macroeconomic imbalances may not be very likely in the near future, implying that trade surpluses will persist. To address these challenges, China should maintain a multilateral and open international trade and investment system, encourage domestic companies to invest abroad, and collaborate with Belt and Road countries to implement a “Global South green development plan.” This plan aims to support the green transition and economic development in developing countries, which need green technology but lack the resources [para. 31][para. 34][para. 37][para. 39].

Huang Yiping, dean of the National School of Development at Peking University, based this article on a speech given in June, which has been edited for length and clarity [para. 40].