Don’t Fear China’s Industrial Juggernaut

(Bloomberg Opinion) -- Washington is working up a sweat over China's industrial policies. There are fears Beijing will build technology companies and advanced manufacturers capable of squashing American rivals by lavishing aid on favored sectors. Many of the tariffs the U.S. plans to impose are aimed at products generated by this state-led agenda, most of it under the “Made in China 2025” program.

Yet this is less scary than it sounds. History shows us that industrial policies seldom foster innovative or competitive companies. In important ways, they can do more harm than good.

The concept was all the rage in the 1980s – not because of China, but Japan. Some argued these policies were the secret sauce behind that nation's meteoric rise on the world stage. They made the case that bureaucratic management and support for targeted industries created a super-competitiveness beyond the capabilities of the market. The U.S. would have to copy Japan, or die.

The fad eventually fizzled with Japan's economy. After the asset-price bubble burst in the early 1990s and the nation tumbled into its "lost decades," its economic model no longer seemed a world-beater.

Some economists had argued all along that the superiority of industrial policies was an illusion: Their advocates were zeroing in on a handful of success stories and ignoring bigger failings.

Michael Porter and Hirotaka Takeuchi dissected Japan's program and determined that only a few sectors fostered by the state – steel, shipbuilding and semiconductors, for example – became internationally competitive. Others were busts, including chemicals, software and aircraft. Meanwhile, many of Japan's most prominent industries, such as automobiles, motorcycles, video games, robotics and carbon fiber, were never directly targeted by Tokyo's bureaucrats. The authors concluded that “the practices widely believed to explain Japan's success were far more prevalent and pervasive in its failures.”

Nor did all the successes maintain their global stature. The Japanese chip industry was a world power in the 1980s, but has since withered, unable to sustain its competitiveness or technical edge despite continued state efforts.

China's own history helps prove the point. Beijing targeted renewable energy such as solar and wind as strategic sectors. The program succeeded in creating big manufacturers of green-energy gear, especially solar modules, where China now dominates world production.

But that expansion didn't necessarily lead to much innovation. The 2017 Global Cleantech Innovation Index ranks China a middle-of-the pack 18th out of 40, a gain of only one position from the previous list in 2014. That's the highest ranking of any developing country in the study, but still places it behind South Korea, Japan and Singapore. Though China showed signs of improvement in its ability to create green technologies, especially an increase in early-stage investment, it still lagged in filed patents.

Similarly, a 2017 study by experts at Carnegie Mellon University on China's wind-turbine industry noted that domestic firms had relatively few international patents. The country had made great progress in capacity expansion, the authors said, but “in terms of innovation and cost-competitiveness, the outcomes were more limited.” An examination of Chinese green energy by the World Bank in 2017 drew a similar conclusion.

Past performance doesn't mean China's efforts will fail in the future. But the evidence is that there's no firm link between state support and innovation.

There's another way industrial policies could hurt foreign competitors – by creating excess capacity that distorts prices.

In that sense, one can make a case that China's policies could hamper, not help, its technology ambitions. In their Japan study, Porter and Takeuchi argue that by coddling certain industries, the government protected them from the competition necessary to spur success. In China's case, heavy subsidization of industries like electric vehicles could keep too many weak players afloat and crowd out better ones.

So China's industrial program might prove scary. Just not in the way you think.

To contact the editor responsible for this story: Paul Sillitoe at psillitoe@bloomberg.net