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China’s Economic Paradox

Yuen Yuen Ang. Project Syndicate. Sep 4, 2024.

Amid an economic downturn and a local-government debt crisis, President Xi Jinping is accelerating China’s shift to a tech-driven growth model. But rather than ensure a sustainable transition, his strategy has led to a risky dynamic whereby the tech sector is booming while the rest of the economy is slowing.

Western observers often view China as either a rising superpower on the cusp of global dominance or a fragile country on the brink of collapse. These contradictory takes amplify only one side of China’s economic trajectory: a tech boom alongside a growth slump.

This paradox can be attributed largely to the directives issued by President Xi Jinping to the millions of Communist Party apparatchiks tasked with realizing his ambitious vision.

Contrary to the perception of China as a command economy where national leaders deliver precise orders, the logic of what I call “directed improvisation” prevails. Central leaders signal their priorities while the country’s vast bureaucracy – comprising ministries and local governments – interprets and acts on these signals according to political incentives.

Xi has made it clear to Chinese officials that he intends his legacy to be a new economy focused on “high-quality development” and “new quality productive forces” (that is, high-tech innovation). The old economy of polluting industries, infrastructure investment, and real-estate speculation helped lift China from poverty to middle-income status, but Xi has distanced himself from it. He even seems to disdain the country’s previous growth model, associating it with the political rivals and corrupt underlings he has sidelined or imprisoned.

Chinese officials thus have little incentive to take bold steps to revive the old economy: success would do little to improve their standing, and failure could end their careers. This helps to explain the central government’s lackluster response to the ongoing real-estate slump. Had policymakers acted decisively right after the COVID-19 pandemic, they might have restored consumer confidence. By now, however, the economic slowdown has hit not just confidence but also incomes, as more people face layoffs and pay cuts.

Meanwhile, the government’s singular focus on producing advanced-technology products has driven local authorities to over-invest in sectors favored by Xi, such as electric vehicles (EVs) and solar panels. In a recent article, my co-authors and I show that after the central government set ambitious targets for new patents – a standard indicator of innovation – local officials inflated the numbers by encouraging junk patents. Consequently, the share of genuinely novel innovations has declined. We refer to this phenomenon as a “low-productivity innovation drive.”

Although China is remarkably effective at quickly generating massive outputs, this approach results in significant waste. The EV industry is a prime example: China has more than 450 car factories, yet one-third of them operate at less than 20% capacity. Ultimately, most of these producers will likely go bust, leading the industry to consolidate around a few giants like BYD.

Yet there are upsides to this method. Central leaders are willing to tolerate inefficiency and waste as long as they produce champions in the end. Local governments are pulling every trick out of their bags to foster emerging industries, from combining venture capital with public investment to attracting scientific talent deterred by America’s scrutiny of Asian scientists. Notably, China gained more than 2,400 scientists in 2021, as the United States experienced a net loss.

Essentially, the bureaucracy has adapted the communist practice of “mobilization” (colloquially known as “bee-hive” campaigns) to serve the leadership’s capitalist objectives. Historically, this strategy targeted consumer-goods exports, enabling households in the Global North to benefit from hyper-competition within China