Prospects for a trade deal between US President Donald Trump and Chinese President Xi Jinping at the upcoming Group of 20 meeting in Argentina are quite likely to founder on the question of China’s industrial strategies: While Beijing may be willing to buy more American goods to mollify Trump, it almost certainly won’t stop supporting sectors it sees as key to China’s technological and economic progress.

In fact, China would be much wiser to scale back its industrial policies now. They could well turn into a bigger headache for China’s own economy than for the rest of the world.

On the surface, US officials appear to have good reason to fret. The “Made in China 2025” program aims to lavish advanced sectors -- such as new-energy vehicles and robotics -- with subsidies and other support to create national champions capable of dominating global markets. Fearing a deluge of state-backed high-tech exports that would swamp American companies, the Trump administration has demanded Beijing cease such aid as a condition for lifting tariffs slapped on Chinese goods.

China’s billions will certainly have an impact within the country’s domestic market, where the government holds tremendous sway over corporate decisions and consumer choice. Because the state owns so many major corporations, their managers can be compelled to buy domestic rather than foreign wares, whatever their price or quality. China can also make the case that buying local is a matter of national security, given the threat of boycotts or export curbs that could cut off the supply of foreign-made technology.

Outside of China, the task will be much more challenging. First of all, there’s no guarantee that pouring money into favored industries will nurture competitive, innovative companies. The historical record on such programs is mixed at best. China’s current efforts are off to a shaky start. Heavy state subsidization of electric-car batteries has created a lot of companies and factories, but few truly technologically competitive firms.

Out in the real world, stripped of their bureaucratic protection, Chinese companies will have to compete on quality, brand, price, technology and service against established and trusted players -- something their insular managers have little experience or success in doing. A reputation for shoddiness won’t help. BYD has already hit potholes by selling problem-plagued electric buses in Los Angeles. How likely are consumers in the US and Europe to drive their kids to school in one of the company’s plug-in cars, given alternatives?

That leaves Chinese companies competing on price. They’ll have trouble there, too. The level of state support for some of these industries -- whether given directly or indirectly through the state-run banking system -- is so large that foreign governments are almost certain to protect their own firms from Chinese competition. A new study from the Center for Strategic and International Studies, for instance, figures that China’s national and local governments spent nearly $59 billion on the electric-vehicle industry between 2009 and 2017, a good chunk of it subsidizing consumers.

Previous Chinese policies that favored other industries -- such as steel and solar panels -- created massive production capacity and led to a flood of cheap exports that hammered competitors around the world. There are already indications that “Made in China 2025” is spawning similar excess in sectors such as electric vehicles. Foreign leaders are unlikely to sit by idly while wasteful Chinese investment wrecks their own industries. (The Trump administration has already aimed some of its tariffs at products related to “Made in China 2025.”)

On top of that, foreign governments are likely to block some high-tech Chinese products on national-security grounds. The US Congress recently banned video surveillance gear made by two Chinese firms from government facilities due to security worries. US and European companies will think twice before using Chinese-made microchips -- another industry receiving ample state aid -- in sensitive electronics.

China’s industrial support could chase foreign companies out of its home market in key sectors. But domestic demand won’t be enough to sustain industries bloated by government aid, increasing the already-burdensome costs of such policies on the Chinese economy. No longer able to dump its excess on the world, China will find it harder to keep all these new factories in business. That spells more zombie companies and bad loans for Chinese banks.

All of this should be incentive Xi to strike a deal in Argentina that scales back “Made in China 2025” and other industrial policies. Not only would that ease tensions with the US and other trading partners, it could help promote innovation at home as well. The vibrant Chinese private sector is fully capable of developing cutting-edge products on its own. Flooding industries with cheap credit and subsidies only helps weaker entrants stay afloat, crowding out the truly competitive firms that could succeed on the world stage. Xi should appease Trump now. He might thank the US president later.


Michael Schuman
Michael Schuman, who is based in Beijing, is the author of “The Miracle: The Epic Story of Asia’s Quest for Wealth” and “Confucius and the World He Created.” -- Ed.

(Bloomberg)