The Rise of China´s industrial policy

by Barry J. Naughton

Can China's remarkable, rapid emergence as a large economy and technological power be attributed to specific policies, and more generally to a Chinese program of industrial policy? More simply What is it that China has done right? This is the fundamental question that Barry Naughton addresses in his extended essay. Disentangling the threads of China's industrial policies since 1978, Naughton argues that a distinctive, "government-steered market economy," a term articulated by the country's policymakers, is indeed taking shape and warrants serious consideration as a new type of economic system―one that has ramifications far beyond China's borders.

Genres: China, Economics, History, Nonfiction, Politics

148 pages, Unknown Binding

First published April 15, 2021

Reviews

[Felix Brn]

main take away is the important one that there was no Chinese industrial policy till ~2010. most policy was standard infrastructure investment, human capital, marketisation which drove initial rapid growth.

then industry specific industrial policy began, which is very hard to evaluate.

it's clear that it has led to specific sectoral capabilities (solar EVs) but the ambiguity is in whether this drove post 2010 growth and overall industrial capacity. the jury is out.

an important correction to current discourse that conflates all government intervention (eg. infrastructure stem education) with industrial policy which must be sector specific.

[Spinoza Croce · Rating 4 out of 5]

An insightful approach, very helpful to understand the shift that China's government has taken under president Xi. Barry Naughton dissects Chinese industrial policies that have taken place in the last 15 years and shows how these policies have had a role in Beijing's path to claim a place in technological race.

[Liu · Rating 5 out of 5]

Excellent work as usual from Naughton. Although the title of the book is about the rise of industrial policy from 1978-2020, Naughton makes the surprising claim that industrial policy was essentially non-existent in China before 2006. Given the looseness of the use of the term "industrial policy", Naughton carefully defines it as "an intentional effort on the part of government policy-makers to change the sectoral structure of the economy." As an authoritarian post-Communist country, many assume that planning and industrial policy must have been an essential component of China's rise. But Naughton shows that the opposite is true. The highest moments of China's growth miracle in the Zhu Rongji era coincided with the dismantling of China's planning agencies. The real reason for China's miracle growth was its market reforms.

In 2006, China began dipping its toes into industrial policy with the Medium and Long Term Program fo Science and Technology (MLP). Naughton clarifies that this turn doesn't explain China's growth, but was a response to the slowdown of growth from the miracle years of the mid-1990's to mid-2000's. The MLP still wasn't a full-fledged industrial policy, but sowed the seeds for future industrial policy. It offered large guiding principles, but little specific sectoral direction. Although it included sixteen Megaprojects, these Megaprojects were actually quite small.

The 2008 Great Financial Crisis took the impulse for industrial policy and ramped it up. In response to the GFC, countries everywhere responded with large stimulus programs. China had the most vigorous response of all and part of this included its 2010 Strategic Emerging Industries program (SEI). The SEI program chose specific sectoral targets and created a favorable environment to direct investment towards them. In addition, the SEI sectors are at the frontier of new technology and do not have a current entrenched incumbent. Past industrial policy in Japan, South Korea, and Taiwan often focused on "catch-up" where the goal was to emulate current industry leaders. In contrast, SEI targets sectors that are developing the newest technology and aims to make China the leader spearheading innovation. Naughton notes that using industrial policy for new emerging technology is much riskier than using it for catch-up. With catch-up industrial policy, the state has successful examples that it can copy. But with new industries, the state has model to follow and may make many poor decisions.

2015 and 2016 brought the next sea-change in China's industrial policy with Made in China 2015 (MiC2015) and the Innovation-driven Development Strategy (IDDS). While SEI chose sectors haphazardly, IDDS has a more integrated vision of an upcoming technology wave and considers sectors based on their complementarity. In particular, IDDS targets "general purpose" technologies such as semiconductors and AI, which will likely have applicability to all sorts of sectors going forward. In addition, with trillions of RMB in funding, MiC2025 and IDDS represent a massive quantitative increase in support compared to SEI and MLP. According to Naughton, the current wave of Chinese industrial policy is the by far the largest industrial policy effort in history.

In the final chapter, Naughton examines how China implements its industrial policy. While Japan and South Korea mostly used preferential policies to direct private corporate investment, China does that and uses direct government investment. The key instrument is industrial guided funds (IGFs), which function similarly to venture capital funds with the goal of industrial development. Each IGF has a specialty and is created with a particular focus. IGFs are established by an initiating government agency, which then assigns a management agency to carry out the day-to-day operations of the fund. Only 20% of IGFs are managed by the central government, with the remaining operating at the provincial level or lower. After their establishment, IGFs seek limited partners for funding. Although they have been trying to find private sector participation, Naughton shows that this effort has been a failure and IGF funders are generally always other government bodies. Notably, these IGFs' main goal is not to turn a profit and they aren't under any particular pressure to do so. IGF managers are incentivized to acquire intellectual property and develop domestic industry, with profits being less important.

Naughton thinks that it is too early to tell if China's efforts at industrial policy will be successful, but does offer some warnings. First, the dominance of government expenditure has demonstrated a failure to get the private sector onboard and means the government is completely exposed to the many risks of industrial policy in new sectors.

Second, the government guarantees implicit in IGFs means that funds are likely to deviate from market principles and create moral hazards. Markets lead to innovation because ruthless capitalist competition forces firms to become more efficient, or be pushed out of the market. But with government guarantees, firms can plod along without much concern for their survival. While unprofitable firms are naturally culled in the marketplace, it is up to the state to decide when a failing project needs to be closed. While some projects might be upcoming stars that need just a little more support to break through, other may just be zombies propped up by flows of wasted government funding. In addition, many powerful state institutions are invested in these projects, making it politically difficult for the state to impose these costs on these other actors.

Third, the opportunity for "soft corruption" arises. In an environment with a lot of experimentation, most efforts will fail and the government is accepting of that inevitability. However, this gives some actors the opportunity to take IGF funding and make a fake attempt at technological innovation with the intention of failing. That money can then be put to other uses like real estate speculation. This risk has already materialized, with stories of such corruption in the semiconductor "Big Fund." Fourth, the decentralized nature of IGFs means that there will likely be many duplicate projects. With large quantities of government money flowing into projects that don't have budget constraints, IGFs could create a bubble that would lead to a debt crisis.

[Lourens · Rating 4 out of 5]

This is an academic essay that is clear both in formulating the questions it asks and answering them. It is written well.

An incomplete summary:

Industrial policy is defined NOT as general infrastructure, investment in human capital or investment by local governments (China has 10's of thousands). Instead as direct subsidies (through funding, tax breaks, etc) for the development of an industry.

Is China's unprecedented economic growth over the last 40 years a consequence of industrial policy? No.

Real industrial policy in China is new (starting in 2006, ramping up as stimulus following global financial crisis). First through "megaprojects" (2006-7), now (since 2015) through IDDS (innovation driven development strategies). The big, new instrument is the Industry Guidance Fund (IGF). A whopping $1.5T of funding has been allocated to these funds.

The IGF can been viewed as the Chinese state answer to American capital markets. IGFs are funds consisting of state funds, SOE (state owned enterprise) investments and private capital. They invest like Venture Capital funds, private equity funds and take stakes in public companies.

IGFs have the vision to develop General Purpose Technology, and "leap-frog" the cutting edge. They hope to create spillover effects across industries by investing heavily into one.

The IGF that is furthest in its lifespan is the Integrated Circuit (IC) fund, focused on semiconductor manufacturing. Its funds are used for building new fabs (50%) by investing in companies, consolidating companies through M&A (20-30%), and improving the vertical supply chain (packaging etc).

The IGF is a truly novel instrument, and there are valid concerns surrounding the performance incentives and opportunities for (soft) corruption.

China is in its core a middle income country. This massive industrial policy is a gamble. The costs are immense. Time will tell whether this will pay off.

[Pogger G. · Rating 4 out of 5]

I appreciate the time taken to undergo the rigorous analysis in the book. Though as a result of my lack of knowledge in the institutions and gov systems in China, it made following the details a little hard to follow. Still, it was a pretty enjoyable and quick read.

[B · Rating 5 out of 5]

Short summary of China's industrial policy and the major changes since 2005.

[Sara · Rating 4 out of 5]

This book is perfect for those who want to know more about China's industrial policy, a must read!
Even if I don't know much about this topic, I found it easy to understand

[Nick · Rating 4 out of 5]

A good recap on China's economic policies through the years with little more than collected data and not much commentary.

[Tobi Lawson · Rating 3 out of 5]

An important book length essay on a very important subject - the beginning and evolution of China’s industrial policy. I found Naughton's style of writing boring, but worth reading regardless.

[Zhenyao Li · Rating 5 out of 5]

对于工业政策的定义很漂亮，就是国家主动干预一个sector，并期望能够实现更好的经济发展。有建设性地指出中国的经济成功和工业政策没有任何关系，而是很多轮次的经济解绑。 2007年之后中国产业政策迅速出现，但是真正的效果不得而知