China’s rapid modernisation has created first-class infrastructure, the world’s premier export machine, innovative social networks and driven scientific advances. But it has also resulted in burdensome corporate debt, environmental pollution and unprofitable state-owned enterprises (SOEs).
The government, attempting to ease the transition from export-oriented ‘Old China’ to a consumption-led ‘New China’, alternates between fiscal stimulus and tightening. Amid these policy switchbacks, high-tech companies are building formidable franchises underpinned by a wealth of consumer data.
China faces an inevitable transition from the stratospheric growth of the recent past to a mid and eventually low single-digit growth rate. Investment-led growth in China is fuelled by debt, and further rises in debt will exacerbate the misallocations of capital already made and precipitate an eventual crash. Thus a policy of gradually slowing the growth rate looks inevitable, yet many Western observers seem unwilling to credit the authorities with the will to do the right thing and slow down credit growth. Even though success is not assured, China’s awesome economic progress over the past 38 years suggests the nation be given the benefit of the doubt.
Exports continue to grow, but China’s trade surplus is actually in deficit if the US is taken out of the equation. With the government no longer able to afford the 17% value-added tax rebate on exports, this source of competitiveness will fade, causing export growth to decline in the medium term and turning the overall trade surplus into a deficit.
E-commerce, on the other hand, is an ongoing success story. More than 800,000 people (probably ex-steel workers) now work in delivery teams, but there remain tens of millions still working in the old economy who will need redeployment, especially in China’s very own rust belt in the northeast of the country.
With competitiveness at the low end fading and productivity growth in doubt, the whole country needs to follow Shenzhen into the world of high-value-added goods. In other words, huge investments in robotics, artificial intelligence (AI) and electronic manufacturing is called for. The government is rising to the challenge, with research and development funding growing at a rate of 30 per cent each year.
Robotics provide a prime example of how ‘New China’ is emerging. A five-year government plan started in 2016 aims to increase annual production of industrial robots to 100,000 by 2020. In March, China’s National Statistics Bureau has reported that output of industrial robots has increased by 30.4per cent year on year to reach 72,000 units annually (many produced for export). Over a similar period, the number of Chinese companies producing robots rose from 194 to 500 today. State support in the form of subsidies, low-interest loans and tax credits has been a key facilitator of this growth.
Investing in innovation
For those of us in the West who grew up with the epithet ‘Made in China’ as shorthand for a cheap facsimile of the real thing, the concept of China as a hub of innovation is challenging. However, we would do well to remind ourselves that this is the culture which invented gunpowder, moveable type, rockets, and guns (though some would highlight that the West put them to more assiduous use). And with government funding for research ramping up and patent awards rapidly outpacing the rest of the world, the facts do not lie.
China graduates far more students in the STEM (science, technology, engineering and mathematics) fields than the US, and now ranks as the most influential country in four of eight core scientific fields, including computer science, mathematics, materials science and engineering. It is also catching up in physics, with projects including plans to build the world’s largest particle accelerator, at a cost of $6bn.
From copycat to top cat
Despite their well-established rivals, Chinese firms are determined to be at the forefront of the next wave of telecoms technology. In November 2016, China Mobile beat foreign rivals to lead the global 5G system architecture project, which will establish the structure of 5G networks. And earlier this year China established the world’s largest 5G test field, with around 30 telecom base stations being used by China Mobile, Huawei and ZTE to test solutions for mobile internet and the internet of things.
Indeed, the prominent Silicon Valley venture-capital firm Andreessen Horowitz points to signs of a role reversal, with many Chinese models being replicated in the US. Partner Connie Chan highlights LimeBike, a California startup which has adapted the dockless bike-sharing model first rolled out by China’s Ofo and Beijing Mobike Technology for US consumers. Similarly, Apple recently added payment services to its iMessage chat service, taking a page from Tencent’s playbook.
As China transitions from the export-led, SOE-dominated economy of recent decades to a technology-driven world leader, the road will not be entirely smooth due to the myriad challenges its leadership faces. Nonetheless, there appear to be several reasons for cautious optimism as we consider its future. By focusing on companies producing high-value-added goods and on leading their fields at a global level, China may well flourish in the coming years.
Gary Greenberg is head of global emerging markets at Hermes Investment Management