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Made in China 2025

We assess China’s strategy for avoiding the looming middle-income trap
March 2019

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Views and opinions have been arrived at by BMO Global Asset Management and should not be considered to be a recommendation or solicitation to buy or sell any companies that may be mentioned.

The information, opinions, estimates or forecasts contained in this document were obtained from sources reasonably believed to be reliable and are subject to change at any time.

China’s economic slowdown is structural and set to accelerate over the next decade. Its former export-driven growth model lies firmly in the past and the infamous middle-income trap is looming. Population growth has peaked because of the one-child policy; the working-age population is already shrinking, expected to be down 50% by the second half of this century, while the share of the population aged 70+ is expected to triple.

To tackle this slowdown, the ruling Chinese Communist Party (CCP) is engaged in a new programme to jumpstart productivity growth: Made in China 2025. Can this ambitious strategy succeed within the confines of a repressive autocracy?

Risk Disclaimer

Views and opinions have been arrived at by BMO Global Asset Management and should not be considered to be a recommendation or solicitation to buy or sell any companies that may be mentioned.

The information, opinions, estimates or forecasts contained in this document were obtained from sources reasonably believed to be reliable and are subject to change at any time.

It’s essentially a giant exercise in centrally planned industrial modernisation

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Government intervention is nothing new in China, but creating endogenous growth through innovation certainly is. Under Made in China 2025, the CCP is aiming to develop the country from a low-skilled, low-cost manufacturer into a provider of high-end goods and services, specifically focusing on artificial intelligence and machine learning. It’s essentially a giant exercise in centrally planned industrial modernisation, targeting key sectors from transport to telecommunications.

The programme is closely linked to the government’s strategic vision for China’s role as a global super power. The ongoing tensions between China and the US extend beyond trade into the cybersphere, and the Chinese government perceives one aspect of victory as achieving dominance in new technology. Conventional wisdom has it that China will indeed be able to supersede Western technology and create sustainable domestic demand. In terms of artificial intelligence, China does stand at a major advantage to other nations because of its access to a huge amount of data, owing to its large population and absence of privacy laws. But this ambitious industrial policy faces a number of hurdles, which we believe will ultimately render it unsuccessful.

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Innovation of this kind requires creativity, and creativity requires freedom, which is limited in China.

The most pressing problem is that China’s autocratic nature limits its scope for success. The CCP plans to throw money at Made in China 2025 by investing heavily across the different sectors. But kickstarting productivity growth requires more than just funding. It requires human capital – something that China lacks in comparison to its global peers. Through human capital comes innovation, which paves the way for disruption, risk-taking and even failure – all essential for such an ambitious project as Made in China 2025, yet anathema to the CCP. Innovation of this kind requires creativity, and creativity requires freedom, which is limited in China. The CCP is involved across all industries, which generates massive conflicts of interest within this industrial project – would the government wilfully disrupt and destroy itself? We think not.

The Chinese private sector also looks unfit for achieving technological dominance, contrary to popular belief. On the surface, the number of patents filed in China points towards a very inventive society – more are filed there than anywhere else in the world – but, crucially, these are almost entirely domestic. The proportion of those filed abroad is actually very low, suggesting that this is not representative of true innovation at all. Additionally, research and development spending is significantly low – only 5% of Chinese firms spend money here, and it comprises 2% of the country’s overall GDP, behind that of its global peers also deemed to be at the forefront of innovation.

If Made in China 2025 does succeed in catapulting the country out of the middle-income trap, the CCP will become the first repressive autocracy to do so. We certainly recognise the factors that have led people to conclude that China can achieve dominance in technology. However, we believe taking a closer look reveals that China’s low level of human capital will be detrimental to this project.

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