China’s Economic Upgrading

 

 

Amid all the concerns about China’s structural woes, reform policy and economic rebalancing, its industrial sector has been moving up the value-added chain quietly.  More crucially, the sunrise industries are mostly private-sector driven.  While this is an encouraging development, only time will tell how far Beijing will let market forces and the private sector function, as there is an incentive incompatibility problem inherent in the reform process that it will have to resolve.

 

The first signs of industrial upgrading can be seen in the change in China’s export composition (Chart 1).  High value-added products (including machinery, transport and electrical equipment, musical instruments, watches and accessories, optical and medical equipment, high-tech products etc.) account for half of total exports now, with the high-tech portion of these products (including biotechnology, life science, electronics, computers, telecommunication, aerospace, technology etc.) accounting for 30% of the total. 

 

 

The high-tech industries have registered significant growth despite the sharp economic slowdown in recent years (Chart 2).  Notably, output of industrial robots grew by a staggering 436% YoY in July 2016 from November 2015 when the data series was first available.  Overall, high-tech industries, including industrial robots, wind power, new energy vehicles, solar cells, nuclear power and smartphones, have grown by between 15% and 60% YoY since late 2015 when overall output momentum (as approximated by the official manufacturing purchasing managers’ index or PMI) contracted. 

 

 

The emergence of China’s high-tech sector is not an illusion, as can be seen by the steady rise in their export share (see Chart 1).  This sector’s strong and persistent growth momentum is also seen in the EPMI (or PMI for seven emerging industries with strategic importance, including energy saving & environment protection, IT, biology, high-end equipment, new energy, new materials, new-energy cars) sub-component of the Caixin manufacturing PMI (Chart 3).  Despite its high volatility, the EPMI averaged 54.7 between 2014 and July 2016 (the latest data available), compared to 49.2 for the overall Caixin manufacturing PMI and 50.2 of the official manufacturing PMI.

 

 

More crucially, these high-tech industries are mostly private-sector driven, a sign that Beijing is giving the private sector a bigger role in the structural reform process.  Although official data for the ownership profile of these industries is not available, micro- (firm-) level data shows that private ownership account for 80% or more of these industries, except in the strategic segments, such as wind power, nuclear power and semiconductor.  Certain segments, notably the non-critical parts of smartphones production, are 100% privately owned.

 

There is a caveat in this bright spot of China’s new industries though.  The role of the private sector in the structural reform programme has yet to be consolidated.  There is an incentive incompatibility problem embedded in the structural reform process that Beijing will have to resolve.  On one hand, the government wants to promote market-orientated reform to upgrade growth quality which would mean a retreat of its visible hand in driving the economy. On the other hand, its implementation of reforms is still governed by the guiding principle of the Communist Party which insists on retaining control in the system.  

 

How Beijing balances these conflicting objectives will determine the future growth of the private sector.  But the rise of China’s high-tech and high value-added industries is still a light at the end of the tunnel of China’s structural reforms.