A Blueprint for a China-U.S. Detente

As China has reached middle-income status its rate of economic growth has slowed down sharply. For the past four decades China adroitly took advantage of powerful drivers of growth, but several of these have exhausted themselves or turned into headwinds. For example, a huge demographic bonanza has morphed into a drag on growth, as the working-age population has started to decline, and China now faces the prospect of becoming the first major economy to grow old before it gets rich. Also, global trade, for long a boon to China’s wealthy coastal economy, is now dwindling, and rising trade tensions and protectionism make further gains implausible. Moreover, previously fruitful growth strategies based on fixed capital formation, debt-accumulation and environmental degradation have lost traction as volumes have reached levels where marginal returns are unattractive.  Policy makers in China are well aware of the predicament they face. One of their most publicized responses to the growth slowdown has been President Xi Jinping’s “China 2025” strategy, which is a firm commitment to use concerted state-led promotion and support with the objective of moving up industrial value chains and making China dominant in high tech frontier industries. However, “China 2025” has contributed to the growing acrimony between China and the United States, as Washington has assailed the initiative as a violation of the norms of global capitalism and sees it as designed to undermine strategic business sectors in America.  U.S. sanctions on Chinese tech companies and restrictions on access to technologies implemented by the Trump Administration  have only increased the conviction of Chinese leaders that technological autarky is now a question of national security, and has further deepened the sentiment that the two countries are engaged in a new  “cold War .”

It is in this context of slowing growth, trade tensions and tech sanctions that the World Bank has issued a report, “Innovation in China,” (Link) which provides a blueprint for sustaining Chinese growth in a non-confrontational manner. The World Bank, which has been very active in China since the 1980s and sees itself as a trusted and impartial advisor and is now run by  the Trump-appointed David Malpass, co-authored the report with the Development Research Center of the State Council of the People’s Republic of China, (DRC),  a think tank which  advises China’s senior leadership. The combined effort, therefore, is meant to provide a technically-based proposal which reflects the sensibilities of both Chinese and U.S. policy makers.

The conclusions reached by the report are highly significant because they show a path forward which is very different from the “Cold War” clash now assumed to be inevitable in Washington. Whether this faithfully expresses the conviction of either President Xi Jinping or Damald Trump  is unknown but the report does show that there is considerable support within China’s top leadership for avoiding a confrontation with the U.S. by pursuing a technical approach that diminishes the current areas of tension.

The World Bank/DRC report’s primary message is that China can best achieve its objectives by focusing on traditional developmental strategies that have not been fully exploited. The report advocates for deepening governance and institutional reforms in order to facilitate a three-pronged strategy of: 1. Accelerating the diffusion of currently available technologies (the traditional “catching-up” process available to developing countries which operate well below the “technology frontier”);  2. Reducing distortions which currently affect market prices and result in poor resource allocation and 3. Promoting  technological innovation (discovery) on the global technological frontier.

The report espouses a market friendly agenda to promote an innovation economy: the removing of Distortions in the allocation of resources; the acceleration of Diffusion of existing technologies; and fostering the Discovery of new technologies. This “3D” strategy, as it called in the report, defines the government’s primary role as the supporter of markets.

The report emphasizes that the potential benefits from the first two Ds are ample and relatively easy to achieve and should be the main drivers of growth over the midterm, while discovery on the global technological frontier will gain importance over the long term as China becomes richer.  It argues that China could more than double its GDP simply by catching up to the OECD average in Total Factor Productivity, by propagating existing technologies and eliminating the distortions in resource allocation which are endemic to an economy dominated by central planners, state-owned firms (SOEs) and state banks. Moreover, the report supports changing the focus of industrial policy away from targeted support for preferred firms and towards industrial policies that promote level competition. Though SOEs are seen as an integral part of the economy, the report advocates that they be fully exposed to competitive pressure.

This clear statement of priorities expressed by the World Bank/DRC report is highly significant in the context of Washington’s condemnation of current “discriminatory’ policies regarding foreign investments, technology transfer and the protection of intellectual rights in China. In essence, the report insinuates that it is today in the best interest of China to address these concerns in order to accelerate the adoption of foreign technology and best practices and keep China on a path of high GDP growth.

Of course, China has frequently expressed these views in the past: pro-market reforms have been formally espoused in all the government’s policy statements.  However, progress has been slow, and there is now a widely-held outside of China that there has been backtracking during the Xi Administration. For whatever reason, China continues to “talk the talk but does not walk the walk.”  However, the World Bank/DRC report shows that a significant portion of the Chinese political establishment still sees a “win-win” outcome based on self-interested accommodation. Let us hope that politics and personalities will facilitate this outcome.

Trade Wars

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  • KKR sees opportunity in China decoupling (KKR)
  • Banning technology will backfire on the U.S. (FT)

India Watch

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China Watch:

  • Expected returns in China (UBS)
  • China-Russia: cooperation in Central Asia  (AsanForum)

China Technology

 

Brazil Watch

EM Investor Watch

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Tech Watch

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  • Investing in Asian Innovation (Oppenheimer)
  • Trends in battery prices (BNEF)

Investing

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