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Upgrading the “World’s Factory” Through China’s Fourteenth Five-Year Plan

Summary

China’s leaders are meeting in October to finalize proposals for the country’s fourteenth Five-Year Plan (2021-2025). As tensions with the US intensify and economic growth slows, Beijing is under pressure to produce a five-year plan that delivers its “Made in China 2025” ambitions on time and is likely to turn to increased state intervention in strategic sectors of the economy as a central tenet of the upcoming five-year plan.

Having more than doubled its GDP and GDP per capita since 2010 as well as sharply reduced extreme poverty domestically, China can reasonably claim to be a “moderately prosperous society,” reaching the first of its two centenary goals. Sights have now been set on achieving “national rejuvenation,” its second centenary goal, by 2049. Although the exact implications of “national rejuvenation” remain undefined, the term often refers to the restoration of China’s political and economic significance on the world stage. Innovation-driven development remains a cornerstone of “national rejuvenation,” and Beijing established benchmarks in the 13th Five-Year Plan (2016-2020) for measuring China’s progress in next-generation IT, robotics, high-end manufacturing, and a myriad of other high-tech industries.

While already an integral part of China’s development strategy, promoting innovation-driven development by moving China up the global value chain has acquired new urgency in recent years. Rapidly rising tensions with the United States and a slowing economy are putting pressure on Beijing to accelerate the development of domestic high-tech industries. Through this, Beijing can reduce China’s reliance on the US for strategic goods while bolstering the economy’s long-term prospects by increasing productivity growth. Beijing’s emerging strategy for achieving these goals is coalescing around the central role of the state in allocating resources, and during this month’s plenary session, Beijing is expected to formalize this approach as a central tenet of its fourteenth Five-Year Plan (2021-2025). 

Geopolitical Tensions Drive Acceleration

Over the past four years, US-China relations have worsened as trade disputes have broadened to encompass China’s overall approach to economic development. Of particular worry to the US are links between China’s government and Chinese technology companies. While Chinese tech companies like Huawei claim that they would never compromise the security of the networks they help build, Chinese law requires companies to comply with requests by the Chinese Communist Party for network data. This has created fear among the US and its allies that Chinese technology companies have built “backdoors” in their products that would allow them to covertly pass user data to the Chinese government upon request. While the US and its allies have yet to present any clear evidence suggesting that companies like Huawei have installed “backdoors” in their gadgets, they maintain that China’s intrusive laws make their existence plausible.

Concerns over the integrity of Chinese technology have prompted the US to launch several legal assaults against Huawei and seek to humble the telecommunications giant by cutting the company off from its US semiconductor suppliers. Citing national security concerns, the US has gone on to introduce several other initiatives such as the Clean Network Initiative that aim to eliminate “untrustworthy” Chinese technology companies from global internet and telecommunications infrastructure.

From Beijing’s perspective, America’s attacks on Chinese industry and technology, compounded by China’s classification as a “strategic competitor” in the 2017 National Security Strategy, constitutes the sort of behavior expected from a hegemon insecure about its position in the global arena. Well aware that an increased role for China in world affairs would upset the global balance of power, China’s leaders believe that the US feels threatened by China’s rise and therefore seeks to contain it. While announcing “The Global Initiative on Data Security,” Foreign Minister Wang Yi indirectly accused the US of “making groundless accusations against others…as a pretext to prey on enterprises of other countries who have a competitive edge.” As China’s rise continues, Chinese leaders expect this behavior from the US side to continue.

The prospect of continued US efforts to undermine China’s industrial and technology champions is a serious headwind for Beijing’s efforts to upgrade China’s industrial capabilities and develop high-tech industries. Furthermore, combative US actions towards China highlight the strategic weaknesses inherent to relying on international suppliers for goods like semiconductors that are difficult to reverse engineer. The desire to wean China off its international suppliers by developing domestic alternatives was one of the original drivers behind the passage of “Made in China 2025” (MIC 2025), a comprehensive plan for moving China up the global value chain by modernizing its industrial base and making Chinese firms competitive both domestically and internationally. 

Now that recent tensions with the US have confirmed fears about relying too heavily on foreign suppliers, Beijing is under immense pressure to accelerate MIC 2025 before the US takes even more drastic steps that could hinder Chinese industries and their global ambitions. President Xi’s announcement earlier this year, following US moves to cut Huawei off from global semiconductor supply chains, stated that China would invest an eye-watering US$1.4 trillion over the next five years to promote “indigenous innovation,” a central tenet of the previous five-year plan. The move is a telling sign of Beijing’s determination to achieve technological autonomy as a response to geopolitical competition with the US.

A Slowing Economy and Commitment to MIC 2025

Beijing has another and perhaps more compelling reason for accelerating the development of high-tech industries that fall under the purview of MIC 2025. As China’s economic growth slows, it can no longer rely on traditional drivers of growth such as high levels of public investment, an expanding labor force, and foreign trade to deliver continued economic expansion. 

There is growing evidence that the efficacy of public investment has waned in recent years. The rapid rise in the ICOR (investment capital-output ratio) indicates that stimulus measures are providing increasingly smaller returns. In simpler terms, stimulus is becoming more expensive and leaving behind more prominent trails of government debt. 

As China has become wealthier, wages have risen in tandem. While a welcome development to Chinese workers, rising wages have also robbed China’s labor force of the competitive advantage that accompanies low wages. To remain a competitive economy, China needs to focus on getting more out of its workers by boosting productivity. The rapid modernization of the country’s manufacturing capabilities as well as the development of highly productive high-tech industries offer Beijing the best hope of smooth transition. 

Moreover, the departure of international customers to locations in South East Asia due to the trade war and the growing reputation of countries like Vietnam as low-cost manufacturing hubs, a title once held by China, means that the clock is ticking for China to complete this transition. As the economic and geopolitical environment worsen due to COVID-19 and tensions with the US, Beijing is using all of the tools in its vast toolbox to realize MIC 2025 on time.

To continue delivering steady growth, China must find ways to use its resources more effectively. This means increasing worker productivity, which currently sits at US$11 of GDP per hour worked, less than half of fellow middle-income country Russia and over six times smaller than America’s US$66 of GDP per hour. The best way for China to increase productivity growth is to move up the value chain by modernizing its industrial base. China recognizes this, and as a result, more than 530 smart manufacturing industrial parks have popped up in China that emphasize the deployment of technologies like AI, manufacturing robotics, big data, and cloud computing to boost productivity. The positive link between productivity and technology is well-documented, and the development as well as astute deployment of technology will allow China to continue making permanent increases in the standard of living.

Even as factories closed their doors in Wuhan at the beginning of the pandemic, strategic industries continued to operate with support from both the regional and national government. Wuhan is home to Beijing’s efforts to build a domestic semiconductor industry and became the focal point of a nationwide push to reduce reliance on foreign suppliers after the US subjected ZTE, a smartphone company, to technology bans. Yangtze Memory Technologies, which recently launched mass production of flash memory chips that mark a significant step forward in the development of a homegrown chip industry, continued to operate its factories in Wuhan normally thanks to cooperation with the government on logistics and procurement. Beijing’s special treatment of strategic industries at the height of the pandemic reveals the length to which it is willing to go to realize MIC 2025 on time.

Institutional Advantage

The previous five-year plan (2016-2020) made extensive promises to liberalize the Chinese economy, shift from investment-driven growth towards consumption-driven growth, and allow the market to play a greater role in allocating resources. Indeed, the Chinese government has kept many of its promises to liberalize the economy. Under the framework of President Xi’s “Opening-up Initiatives,” Beijing has simplified financial market regulations that make it easier for foreign financial institutions to enter the Chinese market. 

However, Beijing’s commitment to liberalization across the board has been far from consistent. In industries covered by Made in China 2025, the trend has been shifting toward protectionism as Beijing pushes a number of reforms that create an uneven playing field for foreign companies and award leverage to Chinese ones. Of particular concern to foreign observers are support from state banks for strategic industries and the requirement that foreign companies share their IP with a local joint venture partner in order to operate within China. 

While Chinese state capitalism attracts criticism for some of the inefficiencies it engenders, President Xi often trumpets China’s mixed economy as an “institutional advantage,” or the idea that China can productively allocate resources at a moment’s notice by marrying the innovative spirit of private enterprise with the raw power of the state. While seemingly content to allow market forces to play an increasingly important role in the development of industries that will not play a key role in driving growth or strengthening national security, China’s “institutional advantage” allows it to deploy resources en masse to industries that will.

Looking Forward 

China has grown by leaps and bounds over the past decade and already achieved its national objectives for 2021. However, to achieve “national rejuvenation” by 2049, the country must reduce its reliance on foreign technology suppliers and boost worker productivity. Previous five-year plans have emphasized these goals, but by vacillating on the approach that it will take to achieve them, Beijing is sending an unclear message to foreign companies about the role that they should expect to play in China’s development.

Geopolitical competition with the US and a slowing economy are the latest drivers accelerating the longstanding tug-of-war between economic liberalization and party control in China. Managing these conflicting ideologies have been central to China’s growth story since Deng Xiaoping first opened China’s economy to the world. As China transitions to an innovation-driven economy, its leaders are rebalancing their country’s development model to include a greater role for the state in industries that are of consequence to China’s military and global economic competitiveness. In the run-up to October’s CCP plenary to finalize proposals for the 14th Five-Year Plan (2021-2025), China’s leaders have taken their cue from President Xi and are following his lead on this approach. When Beijing produces its much-ballyhooed development blueprint early next year, expect it to formalize the state’s expanded role in strategic industries as a cornerstone of China’s development model for the foreseeable future.

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