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China's hedge against geopolitical shock

Mar 16,2022 - Last updated at Mar 16,2022

SHANGHAI  —  In terms of geopolitical impact, nothing could be more important than the United States’ shift from strategic cooperation to strategic competition with China. This change has darkened many observers’ views of China’s economic prospects, as indicated by a Bruegel report released late last year. The assumption, it seems, is that China has no choice but to retreat from its successful development path and embark on a less prosperous path toward self-reliance, with the state exercising complete control over the economy to hedge against geopolitical shocks. But China’s efforts to bolster its self-sufficiency in some areas are a reasonable response to external pressures, and they hardly spell doom for its economic model or prospects.

In recent years, the US has ramped up its effort to “contain” China’s rise. Beyond employing tariffs and non-tariff barriers on imports from China, it has been limiting Chinese investment, such as by blocking Chinese companies from acquiring firms in some high-tech sectors in the US. It has also continued to add Chinese firms to its so-called Entity List, thereby restricting their access to US-controlled critical technologies like semiconductors, barred US capital from entering some of China’s strategic industries, and forced Chinese companies off US stock exchanges.

As my co-author, Shuo Shi, and I show in a 2020 paper, these policies could only carry escalating strategic costs for the US. And, contrary to popular belief, their lasting impact on the Chinese economy could be very limited, let alone enough to stop China’s economic rise in its tracks.

An even more important point is missing from this discussion. China has already crossed a crucial threshold in terms of technological strength as measured by the stock value of physical- and human-capital accumulation. It is now only a matter of when, not if, China catches up with the US technologically.

Chinese leaders have been clear that the country must move faster toward global technological parity to better mitigate the risk from geopolitical impact. In recent years, the government has boosted spending to strengthen China’s capabilities in basic and strategic sectors, including education, science and technology, agriculture, and renewable energy. It has also implemented policies aimed at supporting the rapid development of cutting-edge high-tech industries, such as big data, cloud computing, 5G, and artificial intelligence.

Similarly, in accordance with its Five-Year Plans, China has been expanding its digital infrastructure system. According to China’s Ministry of Industry and Information Technology, China has already established 1.4 million 5G base stations  —  more than 60 per cent of the world’s total  —  with over 650,000 built last year alone.

Such efforts are largely a response to the endogenous need to shift to a more advanced stage of economic development, not simply to US containment policies and geopolitical shocks. Given this imperative, perhaps the greatest impact of the US effort to contain China has been to clarify China’s weaknesses and spur more progress in addressing them.

Chinese authorities do not believe that US containment policies will force China out of the existing global economic system, let alone lead it to embrace an inward-looking, state-controlled development model. Predictions that US policies will have such an effect underestimate the competitiveness gains that have driven China’s economic rise over the past few decades and the profound impact it has had on the global economy.

China has built the world’s second-largest economy, and accumulated vast physical and human capital. It is also deeply embedded in  —  and central to  —  global production, and has formed complementary relationships with advanced economies. China is thus highly unlikely to be pushed out of global supply chains in any comprehensive way.

In fact, even as China has sought to build resilience at home, it has continued to pursue economic liberalisation, such as by improving its business climate, creating a more open financial sector, and establishing many more free-trade zones. And the government remains committed to liberalising the domestic market in order to maintain its linkage with international markets.

Setting aside geopolitical challenges, China must confront its own domestic issues, beginning with an accelerating fertility crisis. Though the Chinese government has eased its overly restrictive fertility policies, East Asia’s experience suggests that fertility may well continue to decline, albeit at a slower rate.

To stem the decline of the working-age population, China is likely to raise the retirement age soon. At the same time, to hedge against the impact of population aging on future economic growth, the government will continue to increase investment in education, thereby upgrading worker skills and raising labour productivity in the long term.

To increase and realise the economy’s growth potential, China urgently needs to commit to productivity-enhancing structural reforms. Here, China should draw lessons from the East Asian economies, where a slowdown in total factor productivity growth has almost always followed a period of high growth.

One such lesson is to resist political pressure to allocate resources to less productive regions. Another is to avoid capital overinvestment in areas, such as real estate, that do not contribute much to productivity growth and that cause macroeconomic instability.

That is why China’s government must pursue challenging structural reforms that correct resource misallocation and enable productivity growth, the scope for which remains large. For example, China should open up more of its economy to private capital. This would help to channel additional resources toward more productive, entrepreneurial sectors, which will use them more efficiently and creatively than state-owned enterprises.

China’s growth and productivity potential is far from being tapped out, and US containment policies and geopolitical shocks will not stop that. But, in order to meet its potential, China must accelerate its structural-reform efforts, as it did in the late 1990s, and improve the allocation of resources by fostering a more equitable, competitive and market-oriented system.

 

Zhang Jun, dean of the School of Economics at Fudan University, is director of the China Centre for Economic Studies, a Shanghai-based think tank. Copyright: Project Syndicate, 2022. www.project-syndicate.org

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