China's Dysfunctional Industrial Policy

Story Stream
recent articles

The Peoples Republic of China's (hereafter "China") economy has been guided by central planning since the mid-1950s, with state industrial policy being developed in a succession of five-year economic policy plans. In China's 12th Five-Year Plan, initiated in 2011, three industrial sectors were singled out, including energy, health care, and technology, with seven designated as "Strategic Emerging Industries." While not specifically considered among the "strategic emerging industries" identified in the 12th Five-Year Plan (except for so-called "clean energy vehicle" production), "automobiles and parts" was designated by China's national government as a "pillar industry" for job creation in both the 10th (2001-05) and the 11th Five-Year Plans (2006-10), and provides a valuable window into the workings of China's modern industrial policy and designated "national champions."

According to an article in The Wall Street Journal ("Chinese Dilemma: 170 Auto Makers", April 10, 2013), the Ministry of Industry and Information Technology (MIIT,) in July 2012, announced that China has 171 domestic automobile, truck and bus manufacturers, with many of them manufacturing only a few thousand vehicles annually. Many of these vehicle manufacturers, who are major employers (a critical "pillar industry" factor so designated by the Chinese government during the previous decade), are considered by local Chinese governments as "local champions;" consequently, they provide Chinese consumers subsidies in the thousands of yuan when they purchase from a local manufacturer. Government subsidies are allegedly so pervasive that the U.S. government formally filed a case with the World Trade Organization in 2012, arguing that the Chinese government unfairly supports vehicle and parts manufacturers. While the Chinese government vehemently denies its subsidies its vehicle or parts manufacturers, its' local governments openly offer a variety of subsidies, ranging from free land for expansion of operations to loan extensions for companies dealing with cash-flow problems, to its local automotive champions.

China, which manufactured 19.27 million automobiles in 2012, and whose top 10 automotive groups are expected to have combined capacity to manufacture approximately 35 million vehicles annually by 2015, is forecasted to have significant automotive overcapacity within the next three years. In July 2012, MIIT announced, however, that passenger vehicle manufacturers that produce fewer than 1,000 vehicles for two consecutive years will be ordered to "overhaul production" - whatever that means. China reportedly has overcapacity in a wide range of industries, from steel to construction equipment to solar panels, for which the central government had encouraged significant financial investment in previous five-year plans. While MIIT may be signaling a reduction in economic support in certain industrial sectors, local governments, however, are still encouraging further capacity expansion by their local champions, who are also their major employers.

Professor Michael Porter of the Harvard Business School, in discussing his "Diamond" framework of factors creating national competitive advantage in his seminal book The Competitive Advantage of Nations (1990), identifies basic policy approaches that governments should embrace to play an important supporting role for the international competitiveness of national firms. Drawing from a complimentary Harvard Business Review article published in conjunction with his book's release, Porter envisions the proper role of government "as a catalyst and challenger; it is to encourage - or even push - companies to raise their aspirations and move to higher levels of competitive performance, even though this process may be inherently unpleasant and difficult." Porter goes on to say that "government policies that succeed are those that create an environment in which companies can gain competitive advantage rather than those that involve government directly in the process, except in nations early in the development process. It is an indirect, rather than a direct, role." After three decades of rapid industrialization and economic expansion, China no longer qualifies as a nation that is "early in the development process." In the second quarter of 2010, China's Gross Domestic Product (GDP) made it the second largest economy in the world.

China's industrial policy is not based in certain fundamental attributes of Porter's "Diamond" framework of national competitive advantage, specifically the often limited home-market demand for a strategic industry's products or services, and the lack of intensity of domestic rivalry, in particular, as an intense domestic market rivalry drives firms to continually innovate. In China's case, the designation of "national champions" is established through centralized Chinese government five-year economic plans, and not by Chinese national champions emerging through intense competition and rivalry in the domestic market driven by consumer demand. For example, a significant problem for China's domestic automobile manufacturers is that approximately two-thirds of domestic sales are to foreign automobile manufacturers, which is due to their reputation for quality among Chinese consumers. As discussed earlier, this situation is exacerbated by the widespread local government support of local champions through direct and indirect subsidies, encouraging substantial market inefficiencies and growing automotive overcapacity in the Chinese economy.

The development of Chinese national champions is thus built primarily upon an export market; in the case of automotive manufacturers in 2012, approximately one million automobiles, or only 5.2 percent of overall production, sold in foreign markets. This is contrary to the successful industrial policy model for another Asian economic power, Japan, which has developed a large number of internationally competitive firms in different high value-added industries, including automotive, construction equipment, consumer electronics, machine tools, shipbuilding, and steel manufacturing, all the result of intense competition in the Japanese home market, with the "winners" becoming globally competitive MNEs. Under China's dysfunctional industrial policy, in the automotive sector this outcome has simply not materialized.

Thomas Hemphill ( is a policy advisor to The Heartland Institute, and professor of strategy, innovation and public policy, School of Management, University of Michigan at Flint. 

Show commentsHide Comments

Related Articles