The high technology industry has become a new growth engine for many countries. China, the second largest economy in the world, has also been playing catch up to close the technology gap. However, it still lags behind its neighboring countries, such as South Korea and Taiwan, which achieved economic miracles well before China. Douglas Fuller examines the reasons behind this, asking why China has far fewer tech giants compared to South Korea and Taiwan despite its unprecedented economic success. Fuller concludes that it was China’s ineffective pursuit of industrial policy and excessive state regulation of the market that have impeded the development of the tech industry.
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This report attempts to explain the limited emergence of Chinese technology titans. The first section examines the structural reasons there has not been great success in pro-active (as opposed to passive, tariff-driven infant industry protection) industrial policy in building technology-intensive firms in China. The second section turns to look at how sectoral characteristics shape the opportunities for technological upgrading among Chinese firms given the state’s policies outlined in the first section. The third section addresses the important issue of market regulation and how that has impacted upgrading in various industries. The fourth section examines the critical role that foreign venture capital has played in China’s technology sector, and the implications of the current surge of domestic venture capital. The final section will address continuities and departures with China’s past industrial development in Xi’s industrial policies.
The Sorrows of Industrial Policy
In the case of China, there are four serious constraints to the effective pursuit of industrial policy: (1) the structure of the state apparatus, (2) the bias of credit allocation toward SOEs/state-favored firms and the resulting managerial deficiencies of these firms (3) the information asymmetries due to sheer geographic size and population of China and (4) the balance of exports vis-à-vis procurement. These obstacles are in addition to the incentives for local officials that prioritize investment and land grabs over implementing upgrading of local firms and multinationals within their jurisdictions discussed by Fuller (2016, Chapter 2).
Sectoral Characteristics and Success
There has been variation in technological catch-up across sectors in China’s economy. For more medium-tech technology, machinery-based sectors, China has experienced a fair amount of upgrading among domestic firms (Brandt and Thun 2010, 2016). For many high-technology sectors, China’s record of catch-up among domestic firms has been weak, and hybrid firms located in China but financed from outside of China have driven technologically upgrading. And in most be noted that for even the mature, medium-technology industries, Brandt and Thun (2010, 2016) find little evidence for effective industrial policy beyond the tariff barriers that encourage multinational corporations (MNCs) in these industries to set up factories in China.
There would be no problem with such a hybrid model of high technology development except for two issues. First, industrial policy has wasted a tremendous amount of resources on the domestic firms in high-technology areas. Second, the hybrid model itself is under threat as will be discussed later in this report.
Regulation of Competition
Brandt and Thun (2016) in revisiting the machine sectors they analyzed over time have concluded that some sectors were much less successful than others even though they shared the benefit of MNC suppliers investing in China. They concluded that the state regulation of market competition to keep out rather than encourage competition was holding back those sectors that achieved less upgrading. The auto industry is a case in point. The state kept primarily private firms from entering into this market for decades, and consequently, the local state champions, despite benefitting from being the partners of the joint-ventures (JVs) required for MNCs entry, failed to upgrade effectively. In contrast, construction equipment, where there was a veritable free-for-all of foreign, state-owned, private, and other firms in the gray corporate area between state-owned and truly private, witnessed impressive upgrading. To underline Brandt and Thun’s point, the most promising domestic carmaker today is a late arriving (due to state barriers to entry), private firm, Geely.
Domesticating Venture Capital
Virtually every big name in technological or business model innovation in China that emerged out of the start-up scene over the last two decades received the majority of its funding from overseas venture capital (VC). From the triumvirate of Baidu, Alibaba and Tencent (BAT) to more recent success stories, such as Xiaomi, foreign venture capital has played a critical role in China’s start-up scene. In short, VC was the main conduit for creating the hybrid firms driving China’s technology development.
Why has foreign venture capital played such an outsized role? Prior to 2007, one could point to the fact that China did not have the legal framework for general-limited partnership structures commonly used for venture capital in the U.S., U.K. and elsewhere. However, even after this problem was resolved through revisions in China’s Partnership Law, foreign venture capital has still played an outsized role in China’s financing of technological entrepreneurship.
One way to understand why this has been the case is the bridging function foreign venture capital plays in linking Chinese entrepreneurs to institutions abroad better able to support technological entrepreneurship. Whereas the domestic stock markets remain unattractive due to its speculative nature (due largely to the dearth of large institutional investors) and the state’s slow and biased process of deciding which firms can list, foreign venture capital has deep experience in listing start-ups on stock markets abroad
Continuities and Departures in Industrial Policy under Xi
The MiC 2025 builds upon previous announced policies of the past ten years, and not surprisingly exhibits some of the flaws of past industrial policymaking. First and foremost, too many state-owned firms are the vehicles of choice for pursuing these industrial policies. Second, and worse still, the funds provided for these industrial policies are often used to spur the state takeover of private (often nominally foreign) companies and assets. Third, state procurement appears once again to be one of the preferred means of supporting these industries. Given that such procurement is not typically distributed to the most capable firms, much of the spending on these various industries may prove to be both ineffective and wasteful.
Understandably, the scale of the proposed plans has alarmed foreign companies and countries alike. Even if China’s flawed industrial policymaking process does not lead to success, it may still lead to adding large amounts of capacity in various sectors. In other words, there is the possibility that relatively ineffective industrial policy could create a lose-lose situation in which inefficient Chinese capacity crashes the global market in a certain good (e.g. DRAM) without actually spurring sustainable development in China. However, I expect going forward that these industrial policies will face both financial and human capital constraints that limit the effective added capacity in some of these sectors. Of course, these industrial policy limitations are unlikely to alleviate the American government’s concerns about loss of intellectual property via forced transfer or theft as outlined in USTR’s 2018 Section 301 report.
Douglas B. Fuller is a professor at City University of Hong Kong. The focus of his research is innovation, technology policy and international business. He has previously taught at Zhejiang University, King’s College London, Chinese University of Hong Kong and American University in Washington D.C. He has led research projects sponsored by the Alfred P. Sloan Foundation and the Savantas Policy Institute of Hong Kong. Fuller is the author of Paper Tigers, Hidden Dragons: Firms and the Political Economy of China’s Technological Development, and a co-organizer of Network B (Globalization and Socio-economic Development) of the Society for the Advancement of Socio-Economics.