BY PHILIP KOTLER – China and the U.S. represent two opposing systems for running an economy. We will know in twenty years which system performs better in GDP growth, product quality, and innovation. We will also have a clearer understanding of the economic and non-economic gains and losses with each system.
The Chinese government is highly involved in guiding the future of its economy. China’s long term technology strategy is titled “Made in China 2015”. China is making decisions and larger investments in science, technology and innovation. The U.S. government chooses not to guide the future of its economy but to leave science, technology and innovation to private enterprise. My worry is that China will outperform the U.S. and become dominant in many of the new technologies. I hope that I am wrong.
China’s new “lifelong” leader Prime Minister Xi Jinping is setting long terms goals and plans for the Chinese economy and enforcing them in centralized and authoritarian ways. Xi announced the goals at the 19th Party Congress in a three-hour, 30,000-word political report to 2,000 party leaders. This happens once every five years and the Communist Party’s 2,000 party leaders wait eagerly to hear the economic plans.
What is China Planning to Do?
China today is the world’s largest manufacturer. Chinese goods include iron, steel, aluminum, textiles, cement, chemicals, toys, electronics, rail cars, ships, aircraft and many other products. Almost 80% of all air conditioner units are created by Chinese businesses. China is a major world producer of computers. China is also the biggest producer of solar cells, shoes, cellphones and ships. China is already the top world auto vehicle manufacturer, around 23 million or double U.S. production. China uses twice as many industrial robots as the U.S. In China, mobile payments are 50 times more than the number occurring in the U.S. And China has laid down more high-speed rail than the rest of the world combined.
China is bent on becoming a dominant player in many technologies such as AI, IT, and 5G communications. A US News and World Report stated that China now has more top ranked engineering schools than the U.S. China is catching up on patent applications and have had the world’s fastest computers for years. It aims to grow its AI industries to over 150 billion yuan ($22.15 billion) by 2020 and 400 billion yuan ($59.07 billion) by 2025. AI global leadership will ultimately lead to global leadership in military power, car manufacture, drones development, and many other sectors of the economy.
China has plans to achieve global leadership in the renewables of solar and wind energy. As it succeeds, China’s energy costs will fall and give China a major competitive cost advantage in the manufacture of other goods and services. As it succeeds, China’s energy costs will fall and give China a major competitive cost advantage in the use of renewables to manufacture various goods and services.
Prime Minister Xi aims to transform China into a “country of innovators”, focusing on aerospace, cyberspace, transportation, solar, robotics, cloud computing, e-commerce and cloud computing. Its 12th five-year economic plan 2011-2015 identified seven strategic industries of high priority: biotechnology, information technology, new energy, environmental maintenance, new materials, high-end manufacturing and alternative fuels.
Chinese companies have already developed several major software platforms. Its Alibaba Group is a challenge to Amazon’s platform. Its Tencent Ltd. is a challenge to Facebook’s platform. Its Baidu Inc. is a challenge to Google’s platform. The three Chinese platform companies are spending heavily to develop artificial intelligence for consumer finance, e-commerce, self-driving cars and other applications.
China plans to modernize its store-based and online retailing platforms. China has a higher ratio of online to store-base commerce than the U.S. It is planning a great increase in shopping malls and private retail markets. This will help boost internal tourism and increase visitor awareness and sales of so many of its products. China is also serious about increasing its health care sector to improve its health care service to its growing middle class.
Prime Minister Xi has a bigger Chinese Dream. He wants to renew the old Silk Road connecting China to Europe and Africa. He calls this China’s “One Belt, One Road” initiative. This is the basis of China’s global trade expansion strategy. It will create a logistics infrastructure linking China with supply and market opportunities in Asia, Europe, Africa and South and Central America and it will also aim to expand China’s influence. China created the Asia Infrastructure Bank to help raise one trillion dollars to improve road and air transportation through China, to Iran to Turkey to Germany and Western Europe. He also will build a “maritime silk road” from Southern China to Malaysia, to India, to Pakistan, to Oman, to Kenya and on to Greece.
While building this Dream, China has done its best to limit foreign competition from coming into China. It has established compulsory certification and standards requirements that slow or block the entry of foreign products into the Chinese market. China requires the disclosure of technology secrets and other proprietary information or excludes the U.S. products from coming into China. China has copied or pirated much U.S. intellectual property. It also imposes foreign investment and ownership restrictions such as 50 percent maximum ownership of car plants and minority ownership limits in sectors ranging from new energy equipment, to telecom, to genetically modified organisms. China also protects a list of their “security” industries.
President Trump recently threatened to wage a trade war with China over its stealing of America’s technology secrets and the fact that China’s doesn’t permit a level playing field for American companies operating in China. This trade war threat had a recent positive effect in that Prime Minister Xi, in a recent talk at the Bao forum, announced a direction of greater China imports, protection of foreign IP, easier foreign business operations in China, and incentives for greater FDI in China.
Can China Pull Off Its Ambitious Plans?
We know that it is easy to create new plans and very hard to execute them. Americans might take comfort in being aware of the vast problems facing China’s economy that will interfere with executing their plans. Here are China’s main barriers to execution.
- China has a huge indebtedness. China’s debt is growing faster than its economy. The ratio of China’s total debt to its GDP is a whopping 282%. Much of this is due not to the federal government but to local governments that needed a lot of credit to grow their local economy. Consumer debt in China is under good control because the Chinese still are high savers. But China’s rising debt to GDP ratio will require Chinese government bodies to control their debt level. The U.S. ratio of government debt to its GDP is 107%, a much safer level but high enough to lead the U.S. government to try to cut its budget in several areas.
- China manages a large part of its economy through less efficient state-owned enterprises (SOPs). About 25 percent of China’s economy is managed by state-owned enterprises (SOEs), several of which are in bloated industries like steel, coal, and cement. Some “zombie” SOEs are sustained for political reasons such as to support employment goals. Most SOEs have to bend their goals to political pressures instead of focusing only on economic factors. Some of these SOEs won’t have the resources to deliver on planned scientific, technology and innovation goals.
- China’s manufacturing costs are rising due to worker shortages and falling labor productivity. Chinese enterprises need to pay higher wages to attract workers and at some point it becomes better to send low-end manufacturing into lower cost Asian countries such a Cambodia and Laos.
- Another area of low productivity is Chinese agriculture. China employs over 300 million farmers and ranks first in worldwide farm output. But farmers in China are less skilled and productive than farmers in some neighboring countries. Their incomes are too small to buy modern farm equipment. They don’t get sufficient objective information on which crops to grow. About 25% of their fruit and vegetables rot before getting to the intended market.
- Corruption is a major problem in China that leads to many transactions not based on creating real value for the society. Suppose that the local government in a Chinese city along with party cadres, investors and local banks agree on the need to build a new power plant. To get approval, it may be necessary to bribe the mayor and some officials. The leader of the power plant company needs to appoint persons to various positions such as purchasing, finance, operations, marketing. The leader may chose cronies who pay him a bribe. Each crony then needs to choose among suppliers, and may chose the supplier who offers the highest bribe. Bribing goes on by state-owned enterprises and private companies, leading to inefficiencies and less able personnel. Prime Minister Xi is currently making a major assault on these corrupt practices.
- China has a disturbing genetic imbalance of men and women. The Chinese government decided in 1979 to establish a one-child policy to keep China’s population from growing too large. Normally this policy would produce 107 boys for every 100 girls born. This ratio will meet China’s needed replacement rate to maintain a stable population size. What happened, however, is about 118 boys were born for every 100 girls. This difference was the result of many Chinese families destroying female fetuses in order have a chance to have a son. This one-child policy has shrunk China’s labor pool, hurting economic growth. Experts fear that the men will marry later because of the shortage of women and may even have fewer children. The major shortage of marriageable young women especially for lower class Chinese could result in an increase of crime and social instability. Even after China changed its policy in the year 2000 to allow two children, many families have not taken advantage of having a second child.
- Many of China’s investment decisions have been plagued by “malinvestment.” Many real estate investments resulted in the creation of “ghost cities,” cities without inhabitants. There may be as much excess housing for 64 million people. And as China’s birth rate decreases, it will be harder to fill these apartments. The cost to China is what advances it could have made in science, technology and innovation with smarter investments.
How is the U.S. Doing in Science, Technology, and Innovation?
Today, the U.S. still has the clear lead in science, technology and innovation. Its colleges and universities are among the best in the world. It has some of the finest engineering schools such as California Tech and M.I.T. Its Silicon Valley continues to innovate new ideas and solutions. It has five of the strongest platform companies called the FAANG group, names Facebook, Amazon, Apple, Netflix and Google.
The U.S., however, has three drawbacks relative to China.
- The U.S. population is 329 million while China’s population is 1.384 billion, or over 4 times larger. American students show a preference for careers in business and marketing, social sciences and humanities. Many talented students aim for a business or a legal career instead of a science or engineering career. In China, an absolutely larger number of college students will go into science and engineering and this training is critical for advancing science, technology, and innovation.
- The U.S. government currently is failing to support its advantages in science, technology and innovation. During Trump’s campaign, Trump largely focused on issues other than technology and innovation policy. When he spoke about the tech industry, his comments occasionally were critical. President Trump has been severely criticized for his anti-scientific leanings. Trump withdrew the U.S. from the Paris Climate Agreement. He has favored government budget cuts in several areas including medical research and climate research. The U.S. has slipped to ninth among OECD nations in terms of research expenditures per capita. The federal government has made cuts in funding for R&D. R&D as a share of GDP in 2016 was the lowest since the Russians launched Sputnik. The U.S. has fallen to 24th out of 39 OECD nations in government funding of university R&D. To restore the federal R&D to GDP ratio to average levels in the 1980s, the federal government would need to invest $65 billion more per year.
- The Chinese government has been systematically pirating U.S. technology. They require American firms operating in China to share their technology. This has to be stopped. Trump’s trade war initiative against China was launched to stop this pirating. But it would have been more effective for the U.S. to have built
“a coalition of the willing” so that more countries joined the U.S. to hurt China if China didn’t stop its pirating.
China’s growing technological prowess is a real threat to U.S. economic and military might. The Chinese government plays a major role in guiding its economy including which industries to grow. The U.S., by contrast, generally avoids choosing which industries to grow. Exceptions include when the U.S. decided to build rockets to get a man to the moon and when the U.S. Department of Defense funded the Internet and helped implement it in a network of universities. The U.S. has also guided industrial development through government funded R&D. The U.S. has pushed the growth of non-renewable energy although Trump recently has tried to restore the U.S. dependence on non-renewable fuels such as coal and petroleum.
The U.S. has a choice between little or no guidance of the economy versus some guidance of the economy. The U.S. has already lost the lead in robotics to Japan and its lead in solar energy to China. Much of the U.S. business community favors less government interference and regulation on the grounds that business performs best when it is free to make its own profit-making decisions. However, there is a tendency of U.S. companies to please Wall Street and make short run profit maximizing decisions rather than long run profit maximizing decisions. U.S. venture capital, on the other hand, has done an incredible job of long term investment. How can U.S. business take care of making the right long run profit making decisions?
The U.S. government must agree to spend more R&D to improve medical tech, energy and environmental tech, agricultural tech, and communications tech. It also need to move more quickly in improving America’s decaying infrastructure which is adding to its costs. Ultimately, the U.S. should encourage the regrowth of manufacturing in the U.S., given robotization, artificial intelligence and the absence of strong unions.
One could propose that the U.S. government should establish a Congressional Commission of distinguished economists and business leaders to look far ahead at the emerging sciences and technologies and identify opportunities as well as gaps. Out of their combined wisdom might come a number of recommendations on which industries the U.S. should bet on and what stimulation and financial aid needs to be allocated. This will lead to surfacing opportunities and to debates on their merits. At best this would approach the model used in France, Germany and Japan of limited but guided economic development. This model doesn’t replace Capitalism but enriches it.