Trade balance composition, 1990-2005

From an economic point of view there is nothing terribly wrong with this. Because of its unique cost and scale advantages, China will be able to generate enormous increases in employment and incomes simply by commoditizing an ever wider range of technologies invented elsewhere. As Figure 5 demonstrates, this widening of China’s industrial base – represented by China’s trade balance in five major goods categories – is proceeding rapidly. In 2005 China was a large net exporter of machinery (to the tune of US$60 billion) and industrial intermediates (US$45 billion), both categories in which as recently as three years earlier it was a net importer. In the long run, these large concentrations of manufacturing capacity, and the development of a richer and more demanding domestic consumer market, are bound to prompt domestic technological innovation.

Yet from the point of view of Chinese planners who define success in terms of maximizing “comprehensive national power” and would like to create local versions of Toyota and Sony, the picture is distressing. When Chinese planners talk of “internationally competitive” they do not simply mean companies that can compete effectively in international markets, which as we have noted many Chinese firms are already able to do. Rather, they mean companies that have globally recognized brand names; intellectual property rights from which they can reap price premiums, royalties and license fees; and control of distribution channels in foreign markets. In other words, Chinese planners explicitly reject the Taiwanese model of small, nimble manufacturing firms that operate mainly on a contract basis with the owners of brands and distribution channels in developed-country markets. Instead they favor the creation of Japanese-style multinational firms.

Common themes of government pronouncements now is the undesirability of China remaining “locked into low-value assembly production,” and the desirability of developing indigenous intellectual property so that Chinese firms can collect rather than pay royalties and license fees. This concern has spawned a number of strategies, including incentive packages for technology industries, the promotion of domestic technology standards, and government procurement rules mandating purchase of domestic hardware and software. The most prominent example of the first was State Council Document 18, published in 2000, which provided a wide range of tax and other benefits for domestic producers of semiconductors and software. These were attacked by US semiconductor makers as an illegal subsidy and were rescinded in April 2005.

The problem with these sorts of policy measures is that by constantly trying to create explicit or implicit discrimination between foreign-owned and domestic enterprises, the government converts what ought to be industrial policy into a trade issue. The two things most required for domestic innovation to flourish and for Chinese multinationals to grow are a) an improvement in the rewards system for innovation (including improved intellectual property protection and more flexible capital markets) and b) and consolidation of industry so that the most efficient players can focus on research and development and well thought-out international expansion, rather than fighting vicious price wars at home in order to maintain market share.

A final consideration is to what extent China’s growth has enabled it to gain power in the international trading system. To the extent that it is now the world’s third largest trading nation, China obviously wields influence over the trade policies of many of its partners. Yet as a new entrant into the WTO it does not as yet gained a significant role in setting the rules of international trade; and insofar as it is perceived as a heel-dragger in meeting its WTO obligations, its impact on further adjustments in the WTO regime is likely to be limited, except in a negative sense (i.e. blocking WTO rules on matters that Beijing sees as helpful protectionist tools, such as government procurement policies). This relatively low level of influence does not yet seem to be an issue of great concern in Beijing, where policy makers are far more engrossed in domestic reform issues than they are in securing a favorable operating environment for Chinese firms abroad. China’s interest in taking a more active role in WTO rule-setting will presumably grow in tandem with the presence of Chinese multinationals in international markets. It is likely, however, that such international concerns will continue to take a back seat to domestic considerations for many years to come.