An automatic robot arm with optical sensors working in factory. Photo: iStock
China is moving to a high-tech manufacturing future. Photo: iStock

Out with the old, in with the new. But this traditional New Year proverb might not apply to China’s economy in 2020.

Overall, this has been a depressing 12 months for Beijing’s policymakers. Signs of stress have appeared in a raft of sectors, including domestic consumer spending, factory production, investment and trade.

Even a brief upturn in the past two months has failed to hide the economic cracks with GDP growth dipping to 6% in the third quarter, the slowest rate in nearly three decades.

Clearly, part of the problem was the trade war with the United States, which dragged on for more than 18 months before a limited phase one agreement was hammered out. This is expected to be signed on January 15.

But the main reason for the downturn has been far-reaching complications in the decision by President Xi Jinping’s government to realign the state-backed economic model to high-tech manufacturing and internet-based services. Consumption, not cheap low-value exports, are pivotal to Beijing’s blueprint.

Linked to the Made in China 2025 policy, this “transition” has proved “harder than expected” during the past four years.

“China’s new economy has long been expected to take the baton of old sectors to carve the future growth story,” Alicia Garcia Herrero, the chief economist, Asia Pacific, and Gary Ng, an economist at Natixis, the French corporate and investment bank, said in report entitled, Is the “New China” Story Over?

“Unlike the labor-intensive traditional industries, the new economy focuses on consumption and value-added products and services through advanced technology. But the economic transition is harder than expected. Although consumption has become more relevant, the slower growth in household disposable income poses new challenges,” they continued.

“Sales of basic goods is resilient but higher household debt is eroding spending on [the] consumption of durable goods. On the higher value-added model, China is climbing up the technological ladder as shown by the lower reliance on foreign intermediate goods but also facing higher global uncertainties,” Garcia Herrero and Ng added in the report released in December.

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Officially, the high-tech manufacturing industry reported robust growth in the first 10 months of 2019.

Profits generated by cutting-edge technology companies jumped 7.5% compared to the same period in 2018, data from the National Bureau of Statistics highlighted at the end of November.

Unfortunately, that was it as the NBS failed to provide further information or significant numbers.

“China’s economy has been transitioning from a phase of rapid growth to one of high-quality development, which has created opportunities for new industries, such as high-tech manufacturing,” Yu Fenghui, an influential economist based in Beijing, told Xinhua, the country’s official state-run news agency, in late November.

But that is only half the picture. Innovation will fail to solve the problems of tomorrow if Beijing continues to strengthen sprawling state-owned enterprises while neglecting the private sector.

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Key industries have been deemed “off-limits,” a study by the Lowy Institute, entitled China’s Economic Choices, confirmed what is widely known inside the world’s second-largest economy.

Indeed, the fear is that the decision in November to set up another fund, this time worth US$21 billion, to develop advanced manufacturing will end up lining the pockets of the usual suspects. In 2018, total research and development spending was $293 billion and was second only to the US.

“China has traditionally relied on its SOEs rather than private companies to execute its industry policies. [It] has set aside designated core industries for either an exclusive or dominant activity for SOEs,” David Orsmond, a professor of economics at the Macquarie Business School, wrote in an analysis for the Lowy Institute, a Sydney-based think tank.

“While in principle, the creativity and efficiency of a company’s operations should not depend on its ownership, in practice public entities the world over do not face the same incentives as those that are privately owned. China is no different, with studies indicating that innovation and efficiency occurs more in its private firms than in publicly owned ones,” he continued.

“While there is extensive evidence that China has a strong capacity to innovate – the internet businesses, on-line finance and so on – these innovations have been driven primarily by private companies with little official support during their development,” Orsmond added.

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Frontier technology also comes at a cost. To move forward, Beijing will need “a wide-ranging policy approach.”

Learning the lessons from Japan and South Korea as they moved up the value-added chain will be crucial.

“High-tech innovation may not add much to the overall pace of growth in the coming years. The authorities have historically had limited success in promoting creativity centrally. In terms of [the] ‘Made in China 2025’ strategy, it is unclear which companies are involved, how the goals are to be achieved, the financing sources or the criteria for funding allocation,” Orsmond said.

“In any event, high-tech innovation that pushes on the global productivity frontier is not where the bulk of the growth advances for China over the next decade are likely to lie. It took decades for high-technology innovation to be a driving force for growth in Japan and [South] Korea. New frontier advances tend to be risky and slow to show success. [In fact,] the slow pace of growth in frontier knowledge is the main reason why advanced economies typically grow at a per capita rate of only around 1% [to] 2% a year,” he added.

What looks certain is that the rise in China’s GDP will continue to slow in the years ahead as the transition gathers pace. Of course, that was always going to be the case.

But relying on “new sectors” will produce a new set of challenges as Garcia Herrero and Ng pointed out in the Natixis report:

“All in all, the sparkle in China’s new economy seems to be dimming measured by the stagnant relative size and the worsening corporate financial health. Although leverage is not a problem (much lower than old sectors), lower revenue and return on capital are weighing down the financial health. Together with the broader picture of slower consumption and household income, this raises the question [about] China’s ability to solely rely on new sectors in the grand economic transition.”

A sprinkling of the “old” might still be needed to add magic to the “new.”

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