Much has been made about China’s 21st century industrial policy, “Made in China 2025 (MIC2025).” Formally unveiled by the Chinese government in 2015, the all-encompassing initiative lifts liberally from Germany’s “Industrie 4.0” plan. This is essentially China’s strategy aimed at transforming the country into another Germany in a decade.
To put this another way, Beijing aims to “become Germany” in the sense of imitating and then surpassing that European powerhouse’s manufacturing prowess. Both China and Germany are surplus countries with formidable export sectors, and the former will continue to maintain a large export sector as well. China just wants to export some of the things that Germany does—fancy cars, advanced machinery, and high-end technology, not jalopies and Christmas toys. It does not want to be stuck forever as an original equipment manufacturer (OEM).
In setting this sprawling industrial policy, China’s decision-makers certainly understand that, much like Japan Inc., an avid practitioner of industrial policy, the nature and quality of a country’s exports directly affect its global reputation. That fact is not lost on Beijing: if a “Made in China” label can be spoken in the same breath as a “Made in Japan” or “Made in Germany” label, then that will do more than anything else to bolster China’s soft power, as well as strengthen its tangible economic power.
This is probably why the Chinese government has become so invested in MIC2025. The State Council, China’s cabinet, now has a dedicated page, in English, on how the policy has enhanced China’s technological reputation.
The reality of Chinese technological prowess is more complex—a theme my colleagues and I intend to explore in this space in the weeks and months to come. But that hasn’t stopped Beijing from touting the maiden flight of the Comac C919, China’s domestically built large commercial aircraft, as one example of a major win under the MIC2025. That the commercial aircraft project began well before MIC2025’s launch is besides the point; aviation is a priority sector, so the C919 fits perfectly with the big new plan as a notable deliverable. (It should be noted, of course, that the completion of this airplane required more foreign suppliers than domestic manufacturers.)
Industrial policy, for the most part, has been maligned as a massive waste of money in which the state picks winners and losers, whether in China or elsewhere. But it is also the case that industrial policy can get some results, especially for projects where private capital isn’t interested, barriers to entry are very high, the sector has few players, and a singular focus—like the C919, Sputnik, and the US moon landing (yes, America practiced industrial policy too).
Where industrial policy usually flounders, however, is in fragmented sectors that already operate commercially and are competitive. Market dynamics, in such instances, are much more powerful in determining outcomes and weeding out the “losers.” Adding industrial policy to the mix, particularly one with MIC2025’s scope and magnitude, can be quite distortionary.
In China’s case, therefore, private sector players often exploit industrial policies to their own advantage to get resources and subsidies. It goes something like this: private businesses lobby local governments by suggesting that their business serves national industrial policy goals and can make local officials look good in meeting their responsibility to support national efforts. Resources and preferential policies in various forms are then conferred on these private businesses.
When the word gets out, many players, often those whose main business has nothing to do with the industry in question, rushes into the sector because local government support essentially means offsetting the initial capital investment. The sector gets crowded very quickly and competition becomes cutthroat, driving down profit margins as new entrants battle for limited market share.
This kind of industrial policy introduces bubbles, isn’t particularly new, and can ultimately lay waste to nascent industries that the government intended to support. A case in point is the Chinese solar industry. It was and still is private sector-led, but local governments all wanted to have solar companies in their jurisdictions because that was the policy signal from Beijing: they were told to support the “industry of the future.”
As a result, all kinds of Chinese players entered the solar game. To illustrate, during the height of the solar boom, I visited a no-name solar company in the middle of coal country in Inner Mongolia. During the visit, the head of the company was as eagerly impressing upon me the fact that they had a huge coal mine in the back as the fact that they were exporting nearly all their solar panels to Europe. The story, as it is clear now, didn’t end well for China’s solar industry, as overheating and overcapacity led to forced bankruptcies and consolidation.
The latest victim of this dynamic could be the Chinese electric vehicles (EV) industry. To get a basic understanding of MIC2025’s objectives for the EV sector, the Chinese industry ministry has created a useful infographic. Note the ambition of reaching a “world-leading” level on batteries and electric motors by 2020, just three years from now.
It’s little wonder, then, that new players are rushing into this sector, hoping to catch this wave before the policy support recedes. China’s central government has long been flummoxed by its inability to shape an auto industry into the mold of that in the United States or Japan—meaning two or three dominant automakers. Instead, the auto sector continues to be highly fragmented and hyper competitive, in part because of local protectionism.
Throw in the latest proliferation of EV makers and the auto sector could get even messier than it already is. Indeed, the EV market segment has exploded over the last couple years, with an estimated 200 startups and manufacturers having entered the sector. Yet the government, if it had its way, would prefer fewer than 20 credible and approved EV makers.
Figure 1. New Energy Vehicle Production Skyrockets
Source: Ministry of Industry and Information Technology.
Although sale of EVs, including plug-in hybrids and pure electric, has held up, production seems to have raced ahead of demand (see Figure 1). In 2016, EV production already exceeded sales by about 10,000 units, and both were up more than 50% from the year before, according to official figures. Moreover, some have estimated that given the current pace of investment in the sector, China could blow through the target of having an annual production capacity of two million EVs by 2020. By 2025, that figure could more than double to nearly six million.
Unlike solar panels, making a high quality, resilient, and commercially viable EV is a much taller order. It is understandable that China wants to leapfrog straight into EVs, just as battery technology is maturing and as Chinese automakers struggle to make a name for themselves in the traditional auto market.
But while winning the “Tesla sweepstakes” is a nice aspiration, achieving it will be much tougher for China. It is almost certain that the 200 or so players will soon experience a culling, turning many of them into collateral damage on the way to industry consolidation.
At least the Chinese government is already sending out warning signals about the frenetic pace of the “EV revolution.” But it’s not clear there is much Beijing can do about it at the moment, unless it demotes EVs on the MIC2025 totem pole—an unlikely outcome. For now, the Chinese government is mostly resigned to being a bystander, observing how this industry unfolds.