Tuesday, 17 April 2018

The Three Acts of the ‘China Shock’

by
Helmut Reisen & Michael Stemmer*


The rising living standards that have come with China´s opening in the 1980s initially lent widespread support to the view of trade as a key engine of economic growth, North and South. The deterioration of China´s terms of trade through the mid-2000s indicated that China´s exports made the world better off[1], raising the purchasing power of its trading partners. Improvements in the range and quality of exports, greater technological dynamism, better prospects for doing business, a larger consumption base, and cheaper consumption goods – all these factors have created substantial welfare benefits for OECD countries.

The rise of China has been shown to be a boon for low- and middle-income countries during the 2000s, benefitting both commodity exporting and non-commodity economies.[2]. As a result, the impact of China’s growth on both the low- and middle-income countries has grown significantly, while the impact of OECD countries has significantly declined.  


The ´China Shock´

Instead of taking satisfaction in global economic development, economic growth in China and the South is regarded by some as a threat. In contrast to the conventional view of globalisation as a win-win setting, recent studies on the ‘China shock’ focus on the job reducing effect of surging imports from China on the US labour market. They suggest that China may have caused poverty to rise in advanced countries, for example in the United States. It is widely assumed, for instance, that the loss of US manufacturing jobs has greatly facilitated Donald Trump´s victory in the last US presidential elections.

The former mainstream consensus that trade could be strongly redistributive in theory but was relatively benign and frictionless in practice has not only been challenged by US evidence[3]. Colantone & Stanig (2018)[4] dwell on the shock of surging imports from China over the past three decades as a structural driver of divergence in economic performance across U.K. regions. They find that support for the Leave option in the Brexit referendum was systematically higher in regions hit harder by Chinese import competition. The German manufacturing sector has on balance gained from rising trade exposure to China (and Eastern Europe), in contrast to the experience of the United States and some European countries. But even across German regional labour markets, there were losers: the Ruhr area, the Palatinate and Upper Franconia[5].

In “The China Shock”, Autor, Dorn & Hanson (2016) trace the substantial adjustment costs and distributional consequences of trade, most discernible in the local labour markets in which the industries exposed to foreign competition are concentrated. They also find adaptation in local labour markets to be slow, with wages and labour-force participation rates remaining depressed and unemployment rates remaining elevated for at least a full decade after the China trade shock commences. This would imply that exposed workers experience reduced lifetime income. These findings suggest that policymakers in advanced countries need to deploy a battery of policies not only to compensate the ´China shock´ losers, but also to counteract trade-related losses with active labour market and place-based regional policies[6].

The ´China shock´ literature does not suggest protectionism but risks being exploited. While unemployment in certain sectors or regions in OECD countries have resulted to a large extent from technological changes rather than from trade, the two drivers are not always easily disentangled. In the OECD countries, both globalization and technological change affect a middle class that is often marked by industry, which has lost its good jobs or is afraid of imminent job losses

Yet, job losses from import competition alone do not give the full picture. By focusing on job gains from China-enhanced globalization, Feenstra, Ma and Xu (2017)[7] show that although the net manufacturing job impact was negative between 1991-2007, it was even for an extended observation period (1991-2011). Such a positive net job effect also exists for the United States since 2009 as Figures 1 and 2 below suggest – absent a newer study.


The Three Phases of China-Enhanced Globalization

What is often missed in analyzing globalization is that the rise of emerging countries has gone and is still going through three distinctive phases. Policymakers risk foregoing the benefits of Asia´s economic rise because they react primarily to the first opening phase of the 1980/90s, which has brought long term cost to the globalization losers. However, important wage and price trends are now being reversed as a result of changes in the global labour supply and of China´s fast transition to a ´New Normal´.

The first phase of the ´China shock´ in the 1980s and 1990s went along with low-skill wage pressures and higher returns to capital in OECD countries. The opening of China, India and the former Soviet bloc had effectively doubled the pool of low-skilled labour. The shape and speed of the newcomers´ integration into the world economy then depended importantly on the transfer of labour from rural low-productivity areas to urban high-productivity sectors. The world economy faced for a while an ´unlimited supply of labour´ at wages not far from the subsistence level. As predicted by the Stolper-Samuelson theorem, the labour supply shock led to a drop in the price of wage-intensive goods that caused a reduction in the equilibrium wage or, alternatively with low wage flexibility, job losses.

The second phase of the ´China shock´, from China´s WTO accession 2001 to the 2008/9 Global Financial Crisis (GFC), saw pervasive convergence of poor countries largely due to increasingly China-centric growth and higher raw material prices. While oil and metal producers benefitted, the majority of OECD countries, being net commodity importers, suffered terms of trade losses. As global trade turned increasingly imbalanced, China became singled out as a currency manipulator and predator. Deindustrialization in some OECD countries became wrongly attributed to external deficits. However, during the 2000s, current account surpluses of around 100 countries had largely arisen in response to the US current account deficit – the excess of US investment over US savings.

The third phase of the ´China Shock´ has since the 2008/9 GFC witnessed a reversal of these trends as China is transforming its production and trade patterns toward consumption, away from investment and intermediate trade. As China´s formerly ´unlimited supply of labour´ has been largely absorbed and its population is ageing rapidly, and as India´s fertility rate has come down, the growth of global labour has peaked[8]. A slowing working-age population will increasingly be mirrored by a rising middle-class consumer population. This stimulates ´ordinary´ global trade fueled by higher consumption, whereas intermediate processing trade has started to stagnate[9]. With China´s wages rising rapidly in both dollar and yuan terms (Figure 1), wage pressures felt in the OECD are probably past.

Figure 1: China´s Manufacturing Yuan Wages 1978-2016, avg. yuan/year
Source: CEIC Database, April 17, 2018


Figure 2: US Manufacturing Jobs 1975-2018, million
Source: US Bureau of Labor Statistics, April 16, 2018

Figure 2 suggests China´s clear footprint on the US manufacturing sector. Over forty years, from China´s initial opening at the end of the 1970s to the global financial crisis at the end of the 2000s, the US lost industry jobs. The decline in manufacturing sector employment accelerated once China had joined the WTO (2001). Since 2009, a mini renaissance has taken place in US manufacturing employment as (Figure 2). The negative distribution effects of the ´China Shock´ are probably gone. Sadly, dwelling on the past is today leading to protectionist measures by some OECD countries. They will not only hurt the emerging countries but also OECD countries themselves, especially if they lead to a global trade war. Curtailing trade is not the answer: Protectionism hurts those the most it is supposed to protect. 



* Helmut Reisen, Scientific Advisor; Michael Stemmer, economist; both at the OECD Development Centre, Paris. This blog post is part of ongoing work for the PGD 2019.

[1] Martin Wolf (2006), “Answer to Asia’s rise is not to retreat”, Financial Times, 14 March.
[2] Christopher Garroway, Burcu Hacibedel, Helmut Reisen and Edouard Turkisch, “The Renminbi and Poor-Country Growth”, The World Economy, Vol. 35, Iss. 3, pp. 273–294.
[3] David H. Autor, David Dorn, and Gordon H. Hanson (2016), “The China Shock: Learning from Labor-Market Adjustment to Large Changes in Trade”, Annual Review of Economics, Vol. 8, pp. 205–240.
[4] Italo Colantone & Piero Stanig (2018), „Global Competition and Brexit“,  American Political Science Review, 25 March, https://doi.org/10.1017/S0003055417000685
[5] Wolfgang Dauth, Sebastian Findeisen & Jens Südekum (2017), “Trade and Manufacturing Jobs in Germany”, American Economic Review, VOL. 107, NO. 5, MAY, pp. 337-42.
[6] Jens Südekum (2017), “Besser als das Arbeitslosengeld”, Frankfurter Allgemeine Zeitung, 23 September; also recommended for the European level by Robert C. M. Beyer and Michael A. Stemmer (2016), Polarization or convergence? An analysis of regional unemployment disparities in Europe over time”, Economic Modelling, Vol. 55, June, pp. 373-381.
[7] Robert Feenstra, Hong Ma, and Yuan Xu (2017), “US Exports and Employment”, http://www.nber.org/papers/w24056
[8] Charles Goodhart and Manoj Pradhan (2017), “Demographics will reverse three multi-decade global trends“, BIS Working Paper No. 656, Bank for International Settlements.
[9] Francoise Lemoine and Deniz Unal (2017), “China's Foreign Trade: A “New Normal”China & World Economy, Vol. 25.2, pp. 1-21.

Wednesday, 4 April 2018

Paradigm Lost



Development matters – not just in poorer countries. Economics, a soft but pretentious social science occasionally unsettled by self-doubt, has adopted an introspective mindset since the global financial crisis erupted ten years ago. The ´markets-work-wonders´ formula of the 1980s (state withdrawal from public services, curtailment of social benefits, deregulated borderless finance, privatised pensions, weakened workers’ bargaining rights) –at times imprecisely dubbed ´neoliberalism´[1] - has left a bland aftertaste. Growth in advanced countries was slow, crisis prone and unjust, failing the bottom third. Today, absolute poverty by global standards hits more than 12 million people in the EU and the US alone[2].

The free market paradigm had been oversold as the only way to achieve prosperity. But the ´End of History´[3]  - Western civilization as the natural order of the modern world - didn´t materialize. Instead we witness state-led prosperity in Asia, but backlash against globalization and rising populism in market democracies[4].

Concerns about the middle-income class in advanced countries have identified bottlenecks, particularly with respect to R&D, upgrading, and skills development. Industrial and place-based regional policies are back on the table. New initiatives try to find a new economic paradigm, yet a new unifying formula is not in sight[5]. Currently, the debate seems lost in the fog of undisciplined complexity. My explanation: The Western debate on a new economic paradigm is still too little inspired by i) development theory, ii) the rise of the developmental state, and iii) the shift of the global economy’s centre of gravity toward Asia[6].

i) The 1940s and 1950s had seen a vivid debate on how to develop the newly independent nations that had just overcome colonial rule. Development economics was born, a number of theories centering on a virtuous circle driven by externalities. In “The Fall and Rise of Development Economics”[7], Krugman distills basic insights of development economics. He dates the beginning of (“high”) development economics with Paul Rosenstein-Rodan´s (1943) Big-Push model and its end with backward/forward linkages of Albert O. Hirschman´s (1958) Strategy, via Arthur Lewis´ (1954) surplus labor model that emphasised dualism and Gunnar Myrdal´s (1957) circular causation. Krugman could have added Alexander Gerschenkron´s (1962) emphasis of industrialization as crucial to catch-up. These early contributions can help us today in the search for a new economic paradigm. They emphasized self-reinforcing development driven by externalities, increasing economies of scale, the fallacies of excessive specialisation, the importance of public infrastructure and of public provision of education, innovation and technology, and the productive potential of urbanisation  in the presence of dualistic labour markets.

Some countries, according to early development theory, remained underdeveloped because they failed to get a virtuous circle going, and thus remained stuck in a low level trap. That view implied a powerful case for government activism as a way of breaking out, especially for building hard infrastructure and providing universal public education. By contrast, attitudes to the state remain much more dismissive in most advanced countries than they were up to the mid-1970s.

ii)  Until recently, the ability of the state to achieve economic goals has been routinely denigrated. Singapore moving to the world top league of rich countries, China´s uninterrupted fast-growth cruise over forty years in the face of misguided collapse scenarios, and landlocked Rwanda´s rise from the ashes of bloody genocide, what do these countries suggest instead? Be inspired by the rise of the developmental state, even if your gut feelings despise autocrats. In terms of economic growth, health and education, accountable autocracies have outperformed democracies when leadership was performance dependent and could be overthrown by a ´selectorate´.[8]

Haggard (2018)[9] reviews the concept of the developmental state that emerged to explain the rapid growth of a number of countries in East Asia. In a second-best world with substantial market imperfections, state intervention can better solve collective action and coordination problems involving private actors and civil society in an iterative process. Based on generous state supply of hard and soft infrastructure, effective industrial policies are forged, helped by selective trade interventions and direct foreign investments. Governments, capable of the patient, long-term, strategic approach essential for innovation, should take an unabashed role as “investor of first resort”—acting as a proactive investor in major innovations, and getting returns on that investment[10]. 
To overcome pervasive rent seeking through private lobbies, the development state imposes discipline on private actors. Such discipline is not only necessary for effective industrial policy but for transitions toward more market-oriented policies as well, according to Haggard´s review of developmental state work. As Danny Quah explains in a fascinating Ted Talk[11], the strong and responsible development state is duties oriented rather than rights based; the alternative to liberal democracy is far off the caricature sometimes drawn as a corrupted, extractive, rapacious structure that exploits its people.

iii) Historically, the rise and fall of superpowers first occur in economics, then politics and policy paradigms, finally militarily. The spread of the Asian economic paradigm to advanced countries on both sides of the Atlantic hits some stumbling blocks, however: English-language publishers still tend to encourage analysis of global affairs from a Eurocentric perspective; Non-Western thinkers often are not translated into English; and scholarly articles on China often seem to stoke China-phobia or overstate the risk of crisis or collapse[12]. 

Asia-inspired policy advice will have to de-emphasise efficiency and re-emphasise accumulation and resource shifts. It will require shaping policy advice for various different stages of institutional development, market informality and duality, perhaps along the ideas outlined in the new structural economics of Justin Lin. Even for high-income countries already at the global technology frontier, some Asian lessons are essential for reigniting growth in rust-belt regions: avoid comparative advantage defying support and identify latent comparative advantages first; then create capacities through government facilitation; not least, build an innovation system that unites public education for skill development, incentives for private-sector R&D and fosters collaboration between private entrepreneurs and the entrepreneurial state[13].



[1] Simon Wren Lewis (2016), “Neoliberalism”, mainly macro, 2nd May.
[2] Angus Deaton (2018), “The US Can No Longer Hide From Its Deep Poverty Problem”, The New York Times, 24th January.
[3] Francis Fukuyama (1989), “The End of History?”, The National Interest, Summer, pp. 1-18.
[4] Ivan Krastev (2016), “The Unraveling of the Post-1989 Order”, Journal of Democracy 16.4, pp.5-15.
[5] Thomas Fricke (2017), “The New New Deal”, https://www.ineteconomics.org/perspectives/blog/the-new-new-deal, 26 May.
[6] Danny Quah (2011), „The Global Economy’s Shifting Centre of Gravity”, Global Policy 2.1., January, pp. 3-8.
[7] Paul Krugman (1994), “The Fall and Rise of Development Economics”, http://web.mit.edu/krugman/www/dishpan.html .
[8] Tim Besley and Masayuki Kudamatsu (2007), “What Can We Learn from Successful Autocracies?”, voxeu.org, July.
[9] Stephen Haggard (2018), Developmental States, Cambridge University Press.
[10] Mariana Mazzucato (2013), The Entrepreneurial State, Anthem Press.
[11] Danny Quah (2017), “Liberal promises, liberal delusions - Emergence of new global powers”, TEDx Talks, 3rd April.
[12] Andrew Sheng (2018), “ The Asian Values Debate Returns”, Project Syndicate, 2nd March.
[13] Justin Yifu Lin (2012), The Quest for Prosperity, Princeton University Press, Chapter 9.

Thursday, 1 March 2018

The Benefits and Costs of Shifting Wealth to OECD Countries


The term ´Shifting Wealth´ has been criticised for conveying a dangerous notion of zero-sum game; dangerous because the rise of protectionism and nationalism in some OECD countries risks bringing the rise of emerging countries and the corresponding meltdown of global poverty to an end. ´Shifting Wealth´ is a shorthand term to describe the gravity shift of the world economy toward the East and the South, in terms of flows (GDP share, South-South trade and finance) and of stocks (changes in net foreign assets, built-up of reserves and SWF assets)[1]. Zero-sum mentality has it that lower poverty in China and in the developing world causes poverty to rise in advanced countries, for example in the United States. Rather than taking satisfaction in global economic development and the unprecedented business opportunities and new jobs it brings also to the OECD, economic growth in the South is regarded by some as a threat. The real threat, however, is a global trade war.

What is often missed in analysing globalisation is that the rise of emerging countries has gone and is still going through three distinctive phases. Policymakers risk foregoing the benefits of globalisation because they react to the first opening phase of the 1980/90s while important wage and price trends are now being reversed as a result of changes in the global labour supply and of China´s fast transition to a ´New Normal´.

The benefits of ´Shifting Wealth´, including to the OECD, are well rehearsed. The rising living standards that came with globalisation initially lent widespread support to the view of trade as a key engine of economic growth, North and South. The expansion of global value chains (GVCs) became a strong driver of productivity, boosting intermediate trade – a boon for OECD producers of equipment and consumer goods. Formerly poor countries used their exports for higher consumption and thus imports, not least for OECD-based luxury brands. Intensified specialisation meant an improved allocation of resources also in OECD countries, with capital and jobs shifting away from their least competitive uses and lowest added value toward higher-income sectors. Consumers in the OECD benefitted from a higher purchasing power of wages as low-skilled goods prices dropped. They also enjoyed more product choice. The deterioration of China´s terms of trade through the mid-2000s indicated that China´s exports made the world better off[2]. Improvements in the range and quality of exports, greater technological dynamism, better prospects for doing business, a larger consumption base – all these factors have created substantial welfare benefits for OECD countries. Overall, Shifting Wealth is a win-win setting.

The problem is that the benefits of Shifting Wealth have been unevenly distributed. Many of the major economic trends of our time - globalisation, digitisation and robotisation - are good for society on average, but not automatically good for everyone. Especially in the labour market, they also generate losers. Besides the fear of mass immigration, these globalisation losers can play a decisive role in the rise of populism. An appropriate policy answer in advanced countries requires a sound diagnosis that distinguishes three phases of globalisation.

The first phase of Shifting Wealth in the late 20th century went along with low-skill wage pressures and higher returns to capital in OECD countries, giving impetus to Piketty´s r>w[3]. The opening of China, India and the former Sovjet bloc had effectively doubled the pool of low-skilled labour. The shape and speed of the newcomers´ integration into the world economy then depended importantly on the transfer of labour from mostly rural low-productivity areas to mostly urban high-productivity sectors. A core model of economic development, the Lewis[4] or surplus labour model, provides the analytical tools: The modern sector – and by extension the world economy (!) – faced for a while an ´unlimited supply of labour´ at wages not far from the subsistence level. As predicted by the Stolper-Samuelson theorem, the labour supply shock led to a drop in the price of wage-intensive goods that caused a reduction in the equilibrium wage or, alternatively with low wage flexibility, job losses.

While unemployment in certain sectors or regions in OECD countries have resulted to a large extent from technological changes rather than from trade, the two drivers are not always easily disentangled. In the OECD countries, both globalisation and technological change affect a middle class that is often marked by industry, which has lost its good jobs or is afraid of imminent job losses[5].

That it is the middle class in OECD countries that has been affected by the initial labour-supply shock has theoretical and empirical support. Krugman (1994) has shown early on that competition will ensure the ratio of the wage rate in the OECD area to that in China to equal the ratio of labour productivity in those sectors in which workers in the two regions compete head to head[6]. Poor countries produce low-tech goods more cheaply, and the fall in the price of those goods will raises real wages in the OECD. So in the past, surplus labour in China and elsewhere has benefitted in particular the low-income segments in the importing countries as low-tech products weigh relatively heavily in their consumption. The key problem, however, for the middle class is the structural change that results from trade pressures in intermediate sectors. Some of these sectors, such as textile, steel and electronics have been shrinking in the OECD as a result of Shifting Wealth.

The empirical evidence that the distribution effects of globalisation and technological change have put a strain on the OECD middle-class has been provided by the “elephant graph” in a paper by Lakner and Milanovic (2013)[7]. The graph shows income gains at each point of the global income distribution for the 20 years spanning the fall of the Berlin Wall to the 2008 financial crisis. The graph has recently been updated for the World Inequality Report 2018 by a team of Berkeley and Paris School economists for the period 1980 to 2016. They identify the trough of low growth with the bottom 90 percent in the United States and Western Europe (the global 50-95 income percentile), while higher income growth has been appropriated by the Asian middle class and the global top 1% income group[8]. The affected middle class in the OECD constitutes a lot of frustrated voters…

The second phase of Shifting Wealth, from 2000 to the 2008 Global Financial Crisis (GFC), saw pervasive convergence of poor countries largely due to increasingly China-centric growth and higher raw material prices. While oil and metal producers benefitted, the majority of OECD countries, being net commodity importers, suffered terms of trade losses. Simultaneously, as a result of reversals in the current account of balances of payment, net foreign assets positions morphed: China and oil producers extended their net credit whereas the US net foreign debt position bulged. As global trade became increasingly imbalanced, China became singled out as a currency manipulator and predator. Deindustrialisation in some OECD countries became wrongly attributed to external deficits. However, it was not ´Shifting Wealth´ that caused US deficits on its current account. During the 2000s, current account surpluses of around 100 countries had largely arisen in response to the US current account deficit – the excess of US investment over US savings.

 As a result of its external deficits, the US risked losing economic, political and normative influence on the world stage. In other words, it risked to become a ´normal´ country, frustrating those who claimed its exceptionalism[9]To be sure, there are some global zero-sum settings. A rebalancing of influence toward China & Co. has seen the relative weight of the advanced countries diminish; and there are pressures for a redistribution of the stock of global commons, particular in relation to climate change and extraction rights for exhaustible resources.

Figure 1: China´s Working-Age Population is Shrinking

.Source: Source: United Nations, World Population Prospects: The 2017 Revision

The third phase of Shifting Wealth has since the 2008 GFC witnessed a reversal of these trends in the terms of trade as China is transforming its production and trade patterns toward consumption, away from investment and intermediate GVC trade. As China´s formerly ´unlimited supply of labour´ has been largely absorbed and its population is ageing rapidly, and as India´s fertility rate has come down, the growth of global labour has peaked[10]. China´s working-age population is projected to shrink by 400 million in the 21st century (see Figure 1). Sub-Saharan Africa and India can numerically offset these demographic trends for the next couple of decades. Economically, the offset is much harder. A slowing working-age population will increasingly be mirrored by a rising middle-class consumer population. This stimulates ´ordinary´ global trade fueled by higher consumption, whereas intermediate processing trade has started to stagnate (Lemoine and Ünal, 2017)[11]. Asia-driven wage pressures felt in the OECD are probably past, with China´s wages rising rapidly in both dollar and yuan terms (Figure 2).

Figure 2: China´s Manufacturing Yuan Wages, 2000-2018

Source: https://tradingeconomics.com/china/wages-in-manufacturing

Longstanding demographic developments that caused income and wealth inequality will now change. This is supported by the fact that several trends, which have been valid for forty years since the entry of post-communist states and emerging Asian countries into the market-economy organized world economy, have ended. Demographic prospects have Goodhart and Pradhan (2018) forecast for the coming decades: The ageing and shrinkage of the world's labour force (outside the Sahel Zone) and thus a higher share of wages in world income;  the decline in massive outsourcing to China and Eastern Europe, thus putting an end to price deflation for labour-intensive goods and hence provide scope for a more restrictive monetary policy in advanced economies, probably leading to asset price deflation; and the trend reversal in the global development of factor relations with an increase in the capital ratio in production and a reduction in returns on capital.

The negative distribution effects of Shifting Wealth are therefore likely to abate. Protectionist measures by OECD countries will not only hurt the emerging countries but also OECD countries themselves, especially if they lead to a global trade war. Cutting off trade is not the answer: Protectionism hurts those it is supposed to protect. To the contrary, “making trade work for all” is required[12]: Compensate the losers, not just with transfers from more progressive taxes. Active labour market policies, skills upgrading and regional policies (Südekum, 2018, op.cit.) as distribution tools are important policy tools as well. Rather than see the “rise of the rest” in terms of the “decline of the west”, policy makers should recognise that the net gains from increased prosperity in the developing world can benefit both rich and poor countries alike. Trade unions in the OECD area will find it easier to negotiate decent wages than they did until recently, with corresponding benefits for PAYG pension schemes.



[2] Martin Wolf (2006), “Answer to Asia’s rise is not to retreat”, Financial Times, 14 March.
[3] Thomas Piketty (2014), Capital in the 21st Century, Harvard University Press.
[4] Arthur Lewis (1954). "Economic Development with Unlimited Supplies of Labor". The Manchester School. 22: 139–91. doi:10.1111/j.1467-9957.1954.tb00021.x.
[5] Jens Südekum (2018), „Besser als das Arbeitslosengeld“, Frankfurter Allgemeine Zeitung, 23 February.
[6] Paul Krugman (1994), “Does Third World Growth Hurt First World Prosperity?”, Harvard Business Review, July.
[7] Christoph Lakner and Branko Milanovic (2013), “Global Income Distribution: From the Fall of the Berlin Wall to the Great Recession”, World Bank Policy Research Working Paper 6719
[9] Stephen Cohen and Bradford DeLong (2010), The End of Influence: What Happens When Other Countries Have the Money, Basic Books.
[10] Charles Goodhart and Manoj Pradhan (2017), “Demographics will reverse three multi-decade global trends“, BIS Working Paper No. 656, Bank for International Settlements.
[11] Francoise Lemoine and Deniz Unal (2017), “China's Foreign Trade: A “New Normal”, China & World Economy, 25.2: 1-21. DOI: 10.1111/cwe.12191
[12] OECD (2017), Making Trade Work for All, OECD.

Monday, 12 February 2018

From Copycat to Global Innovation Driver: Rethinking Technology Transfer with China

From Copycat to Global Innovation Driver: Rethinking Technology Transfer with China, by Thomas Bonschab*

Technology transfer with China seems to have only one direction: Western industrialized countries supply, and China takes whatever it needs. This process does not enjoy a good reputation. Public media are constantly coming up with reports that Chinese companies are blatantly stealing Western technology as part of industrial espionage or breaches of contract. Because many of these stories are well-documented, they have largely sapped the mood towards China.
More heavily weighs the accusation that China operates on a distorted legal framework in order to acquire the desired technology. In fact, Western companies are still being forced into joint ventures with minority share in almost all key sectors, if they want to gain market access in China. Public tenders tend to be designed to grant approvals only when relevant technology is deployed and produced locally with Chinese partners (often assigned by the local administration). In addition, many international investors complain that they are compelled to transfer construction plans to Chinese institutes, thereby giving away their intellectual property. Similar charges comprise the requirement to provide training programs for local employees. And most notably, Chinese authorities are promoting, more or less transparently, M & A processes in the countries of origin of high technology. In Germany, the cases KUKA and Aixtron were widely and critically discussed.
Hence, Western governments are becoming increasingly nervous and trying to strengthen their position on China. Current messages from the US spur concerns for a new trade war. But even the more moderate EU and Germany are trying to impede market access for Chinese players with new foreign trade regulations. It is openly discussed whether China should be granted the status of a market economy due to its industrial policy.

Towards another realignment against China
No doubt, there are good reasons to take action and realign Western policy towards China. However, the approach adopted by most Western countries is problematic. Sure, it may be intuitively reasonable to look at China from today’s perspective or from the perspective of the past 10 years. But there is an inherent flaw in this view. From this perspective, China may appear as a new economic superpower, but still as a technology-developing country that can only acquire knowledge and innovation through unfair ways. From this point of view, the established Western self-understanding of technological superiority is not shaken at all.
This attitude will soon have to be corrected. The real momentum of China’s development is not only to be found in its impressive growth rates of its gross national product. It is rather in its ability to transform itself into a modern knowledge society and thereby to develop so-called indigenous technologies. China may still enter the international stage as a copycat, but not for long. Soon, technology transfer from China to the West is likely to be as common as the other way around. At least in selected sectors of the economy.

Here's a set of common sense considerations that make this trend visible.
Example 1: China as a Land of Inventions: In 1996, the share of research and development in gross national product was just over 0.5%. Although this was above the average of the least developed countries (LDC) of 0.2%, it was far from modern industrialized nations. Since then, annual spending has been growing at an average rate of 22%.

Source: Compiled from United Nations Educational, Scientific, and Cultural Organization (UNESCO) Institute for Statistics.

The catching-up process is unmistakable. In 2015, China has already invested 2.07% of gross national product in research and development. Germany in comparison: 2.87%. As early as 2006, the State Council announced in its "Outline of National Medium and Long Term Science and Technology Development Plan (2006 - 2020)" the target of 2.5% of gross national product for 2020. Since China does not understand such publications as a poem to the people, but instead as a tough promise, one must assume that in the next 10 years, the level of Germany and the United States will be reached. Only the special cases of technology countries such as South Korea (4.2% in 2015), Israel (4.3% in 2015) or Japan (3.3% in 2015) will then stand out.
It is noticeable that we only talk about aggregated data. In key sectors, defined by the Chinese government as part of its China Made in 2015 innovation program, the numbers are likely to be even more significant. New information technologies - notably artificial intelligence and aerospace sectors or biomedicine and the development of high-end medical devices - are investing heavily in achieving rapid independence from Western technologies. The true story is that China will most likely develop indigenous technologies in key sectors, beyond the picture visible when looking at aggregate data.
Example 2: China in patent fever: According to a recent survey by the World Intellectual Property Organization (WIPO), no country registers more patents than China. In fact, as many as the US, Japan, South Korea and the EU taken together.

Trend of patent applications in the five main WIPO offices
Source: WIPO 2016: World Intellectual Property Indicators 2016, Economic and Statistics Series, p. 23

It may well be objected that many of the registered patents are destined solely for the Chinese market, so that not all patens have the high quality to be found in technology driven countries like Germany. Nonetheless, this shows how much China is now presenting itself as a land of inventions and ideas.
The dynamics also suggest the direction in which the currently very critical debate with China on the protection of intellectual property rights (IPR) will develop. A country with so many patents will want to protect them, otherwise they are no value. The according laws in China already exist. Only their consistent implementation by the authorities is still a major challenge. Over the years, this is likely to be remedied. Ironically, in the long run China could become a global protagonist of IPR. Historically, that would follow the example of Japan, South Korea and other countries.

Example 3: "Speed ​​to Market" - from invention to product development: In this core competency for a successful technology transfer, China has already achieved world leadership. Hardly any population has more affinity for new technologies than Chinese. Customers demand constant product adaptation, using social media and the Internet. Successful entrepreneurs have to listen to that voice, or else they disappear quickly from the market. No doubt, poor product quality and product safety are commonplace in China, but are also rigorously punished by customers.
The speed and mentality of Chinese entrepreneurs are set accordingly. Lengthy strategy processes and consultant assignments are not part of Chinese business life. Innovation pressure also comes from the many government programs that operate either through regulations (such as environmental regulations) or market incentives. Market opportunities in the context of "Made in China 2025" or the "One Belt, One Road" program call for maximum flexibility and risk-taking even from the large state-owned enterprises.

Example 4: Incentives for returning intelligence: About 80% of overseas students return to China. That was not always the case. At the beginning of the 2000s, studying abroad, primarily in the USA, was seen as a perspective for a better life. Qualifying Chinese students was very beneficial for the hosting countries, both in terms of financing academic institutions and in terms of developing new technologies, using some of the most gifted minds. This trend has reversed dramatically in recent years.

Source: National Bureau of Statistics of China

Arguably, this development may be caused by a tightening of visa requirements in some countries. The decisive factor, however, is that China offers a more attractive working environment than in the past, especially in key industries. One of the most striking developments is the emergence of the many start-up centers, which were built especially for returning students. At the end of 2016, there were 347 of these centers, with more than 27,000 companies. A technology pool for the future. A perhaps a role model for Western industrial countries.
These are just a few examples of the dynamism with which China is currently developing into a global innovation driver, stripping off its role as a copycat of Western technology. It is apparent that the country will set the tone in future, at least in some sectors. Not just because of its market size or its political chutzpah, but because of its technological superiority. China builds up the necessary resources for this change at a historically breathtaking speed. The days are counted for Western countries to simply blame China as a technology thief.
In the future, therefore, the issue of technology transfer will probably be rated differently. For example, many German “hidden champions” and research institutions in the fields of automation, digitization and Industry 4.0 will step up their development in China in order to be able to sail hard on the wind. It is not only the internal market of China that is exciting, as hitherto. It is also the Asian and global programs along the Silk Road that are perceived as business opportunities. More fundamentally, however, China is above all a new, global competitor in the high-tech sector.
So where is the journey going?
The good news is that German and other Western technology companies are still in high demand in China. Many Western private sector companies are already underway in developing new business models in dealing with China. Re-engineering of technologies should soon go both ways. In fact, there is a lot to learn from China. WeChat, for example, has become a more powerful tool than WhatsApp, Alibaba and other companies have set similar signals. Looking at the Chinese Mittelstand to enter global markets, it is likely to get used to such cases.
At the political level, one can only hope that the approach of co-operation on equal terms and mutual learning curves will not remain a simple rhetoric. European and German advocacy for more fairness in international competition is justified and necessary. The foreclosure of their own markets by means of new foreign trade regulations, however, is rather a step backwards.


*Thomas Bonschab has worked many years for the Gesellschaft für Internationale Zusammenarbeit (GIZ) GmbH in Beijing on bilateral projects between German and Chinese ministries. In 2014, he founded the company TiNC International GmbH together with his Chinese business partner. His company deals with industrial projects in the fields of automation, digitization and industry 4.0, as well as educational cooperations between China and Germany. Thomas Bonschab runs the blog Weltneuvermessung (https://weltneuvermessung.wordpress.com), joint with Robert Kappel and Helmut Reisen, where this post appeared first in German.