How does China do it?

The NYT describes how Chinese auto parts makers are beginning to conquer the world. You wonder once more how it is that China has become so successful in export-oriented manufacturing.  The "fundamentals"--human and physical resources, macreoconomic stability and the exchange rate--are part of the story but they cannot be all of it, since so many other countries have the same advantages or more.

I would point to role of industrial policy as a key ingredient in China's success. In this particular case--the automotive industry--industrial policy seems to have made three contributions. First, the government required foreign companies to enter into joint ventures with local enterprises, ensuring the transfer of technological capacities. Second, domestic content requirements compelled vehicle manufacturers to source more of their inputs domestically than they would have chosen to do at the outset. Economists normally think this is a terrible policy because it breeds inefficient domestic suppliers. (Such requirements are also now banned by the WTO). But this has evidently not happened in China (and also in India), where first-tier suppliers have reached near-frontier levels of productivity. John Sutton, who has analyzed the auto industry in China and India in detail, credits in part the domestic content requirements for this achievement.  Finally, state-owned enterprises have been a breeding ground for private entrepreneurs--as the NYT story makes clear.

Of course, it is always difficult to know what would have happened in the absence of these policies. Die-hard market fundamentalists will argue that China would have done even better if the government had stayed away from the market. But the nature of the Chinese success in this and other sophisticated lines of manufacturing is so unexpected and so impressive that I find that a hard case to make on the face of it. A good dose of market discipline combined with a government bent on enhancing industrial capabilities beats either one taken on its own.

UPDATE: And these days even Larry Summers likes industrial policy it seems, at least for the United States... Check this.

Comments

[Egídio Vaz]

"A good dose of market discipline combined with a government bent on enhancing industrial capabilities beats either one taken on its own".
-I´d like tio highlight the combination between market and government intervention in economy.
LDCs are still forbiden to undertake such policies.
We have in Mozambique a "private sector" totally subsised by USAID or, we have a government behind a "private sector" that pushed for its inteeste!

[Torben]

Dani,
I think you are correct when you say the industrial policy has been behind the success. The same story, although in a different manner, lies behind the Success of South Korea. Carefully designed industrial policy is necessary for the engine to start in the first place before it dies.

[Gabriel M.]

Where's the welfare? Output is not welfare.

At one time, China prided itself with its steel output, but it was doing so at a huge welfare cost. (Including popular campaigns aimed at smelting the steel in the cookware of households.)

I don't care if the Chinese industry has a large output. I care about the welfare of the Chinese.

Maybe it might have been better if China grew slower and funneled some of that wealth into private consumption rather than investments?

[Torben]

Gabriel,
Sure it is important to understand the welfare impacts. But, my guess is it is not so easy to conclude on one side. It is due to such a growth that we see massive global poverty reduction. Moreover, if you take into account the benefits of growth for the future generation, I think it is very hard to argue that the welafre has declined or anything the like.

[alex]

DR: "The 'fundamentals' - human and physical resources, macreoconomic stability and the exchange rate--are part of the story but they cannot be all of it, since so many other countries have the same advantages or more."

Which other countries have the 1st two factors AND China's exchange rate advantage?

To the NYT's credit, the article does mention China's $1.2T forex reserves. Combine that with a trade surplus that will probably hit $400B (overall, not just bilateral with US) and it's pretty obvious that China is manipulating the exchange rate to its export advantage.

While industrial policy (and their high tariffs on imported cars and parts) are a factor, how well do you think their car parts industry would be doing with a yuan that was, say 30% higher? Not very well, I'd say.

[Gabriel M.]

Torben, there's a Golden Rule of sorts. Is China overdoing it or not, in that context?

And let's not forget that China manages huge growth because it comes from a horrendous place.

Much like East European, ex-communist nations, China got a huge growth bust from eliminating endemic and systematic inefficiency generated by... industrial policy. ;-) It's just that it was the previous generation's policy.

[Justin Rietz]

China's policies appear to be beneficial as reflected in their growing economy. However, that is only part of the story, the short-term "seen". There is also the long-term "unseen". A few examples:

1. A huge portion of China's population still lives in abject poverty. Artificially deflating the value of the Chinese currency reduces the poor's purchasing power. (as a side note, there are many documented cases in which the poor in China have been forcibly removed from their homes and land in order to make room for government - industry expansion).

1. How do we know that Chinese automakers wouldn't have sourced domestically even without government regulations? If the suppliers are as productive and efficient as claimed, wouldn't the automakers have chosen them over presumably more expensive foreign suppliers?

And if the suppliers aren't as good as claimed, the government is artifically propping up companies in an industry that may well not be in China's sphere of "comparative advantages". This hurts long term growth via opportunity costs, i.e. the cost of Chinese businesses not focusing on areas in which they would have more of a competitive advantage.

3. Cozy relations between government and industry more often than not result in corruption. This leads to "crony capitalism" and weak companies than can only survive via government connections and protection. The Japanese banking crises is a good example of the consequences of this.

[Mustafa Sabuwala]

This is a classic fallacy of what NNT in his book The Black Swan calls the Fate of Drowned Worshippers. Nobody remembers the devout worshippers who drowned at Sea because there is no one to remember them. Similarly newspapers make the same mistake when they look at a particular industry which has benefited from govt. intervention. The loads of other industries as well as other countries where the same policies were applied are not seen.
A good example would be the Malaysian Car Industry which has been trying to using Industrial Policy to create a National car as well as a local supplier ecosystem which would be globally competitive and it has failed misrebaly.
The Indian example is simply irrelevant because here the Ancillary Parts Suppliers have succedded despite the govt. policy which for decades tried to stifle growth of large players thorough a misguided approach of promoting Small Scale Industries.
The Govt is simply playing favourites very much like Venture capilists who decide to invest in a clutch of companies hoping one will pay off and not knowing in advance which one will.
The difference obviously being that VCs put in their own money while the Govts. put in money collected via taxes and there is no opt-out system in this for the ordinary citizens. The govts are actually worse than VCs with a holier than thou attitude claiming knowledge about what is best for the country without really having a clue.

[jonfernquest]

Wouldn't China follow the historical precedents of successful Japanese and South Korean industrial policies, rather than theory?

"Domestic sourcing" was certainly part of the South Korean automotive industry's development, and mre importantly a fundamental part of national pride, the point when every part in the car was produced in Korean was an important milestone that went beyond and was driven by more than economic logic.

It would be interesting to see if other elements of South Korean industrial policy such as credit rationing and control of unions are also figuring into emergent Chinese industrial policy.

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[oohkuchi]

A lock on the domestic market is still key to Japan's companies' success. Go into any big Japanese electronics store, with tens of thousands of products, and you will often see no foreign brands at all except Apple, which has chic. This is not industrial policy, though--just the deeprooted Japanese distrust of foreign manufactures, in all categories, period. (Cars are another very noticeable example). How they have got away with this blatant discrimination for so long I do not know, but there is no doubt that the near- total absence of foreign competition in so many markets in Japan has given their companies a solid grounding at home that enables them to pursue exports risk-free. It is a lesson China should learn. If the world tolerates Japanese informal protectionism, it will probably let the Chinese get away with it too.

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