Can the Chinese industrialization strategy be duplicated?

Or was it a unique confluence of factors?

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About a month ago, I published an article entitled Understanding the Chinese economic miracle, in which I explained how Chinese economic policy works and briefly overviewed the results. I also argued that the rise of China to become an industrial, political, and military superpower is by far the most important trend of the last 30 years. If you have not read it, I recommend reading that article before this one.

I also wrote several related articles on why value-added export industries are so vital to nations transforming their citizen’s standard of living:

• Why export industries matter so much to material progress

• How developing nations can create competitive export industries

• Why Developing nations need to create thriving export industries

This all leads to an obvious question:

Can other nations copy the Chinese model and transform themselves into a manufacturing and exporting powerhouse on a smaller scale?

Obviously, we do not really know the answer to this question until we actually see another nation accomplish it. For now, we can only speculate based on what we know.

Before answering this question, I want to briefly overview the Chinese economic model and then point out a key weakness of the Chinese model.

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You can read more on how developing nations can experience material progress in this article.

If you enjoyed reading this series of articles, you might also be interested in reading my “From Poverty to Progress” book series:

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The Chinese model

As I explained in the first article in this series, Chinese industrialization strategy goes something like this:

1. Use the following global comparative advantages to lure Western companies to invest in domestic manufacturing plants:

   1. Cheap labor (the most important factor before 2010)

   2. Manufacturing of vast scale and speed (the most important factor after 2010)

   3. The promise of access to the Chinese domestic market (which never seemed to materialize).

2. Copy what the Westerners do, but with cheaper labor and Chinese debt-financed capital. This enables China to quickly copy all the technologies, skills, and social organizations that it took the West centuries to innovate and deploy at scale. This is the “cheat code” of industrialization. Copying what works in richer nations is an essential part of How Progress Works.

3. Gradually ratchet up the value chain toward higher value-added export products. Leverage the necessary technologies, skills, organizations, and capital from existing industries to learn the skills needed for the new industry and use the advantage of cheaper labor to outcompete richer nations.

4. Build the infrastructure needed for a modern urban society so workers can work in major urban areas where the factories are located. The workers do not need to be comfortable or happy, but they do need to be productive and unwilling to revolt against the Party. This is China’s means to achieve the second Key to Progress: Trade-based cities.

5. Vertically integrate entire supply chains within China so as not to become dependent on foreign imports. Once the Chinese get into one step in the supply chain for an industry, they leverage those technologies, skills, and organizations into the next step in the supply chain, until they dominate the entire supply chain within that industry.

Debt, debt, and more debt

Chinese industrialization strategy can be summed up in one phrase: Debt-financed investments in infrastructure and export manufacturing. I mentioned this debt in the first article, but in order to keep the length of the article manageable, I did not go into great detail.

While the material benefits of Chinese capital investments in infrastructure and export manufacturing are massive, but so is the resulting debt load. The United States and other Western nations are also massive, but it is quite possible that the problem is far worse in China (we do not know for sure because the Communist party is not very transparent about the negative side of its regime for obvious reasons)

At a minimum, China’s national debt is $10 trillion. Most likely, it is at least 3-4 times that amount. Even if the first figure is the correct one, this debt amounts to 66% of GDP and $7000 per citizen. Interest payments for central government bonds and municipal bonds are $280 billion per year.

Here is a more realistic Western estimate of China’s actual debt load and composition:

Source

Eventually, this debt must be paid off, and that is going to be an enormous challenge that the Chinese Communist Party keeps deferring. It is very unclear if the negative long-term effects of paying off this massive debt are better than the positive short-term effects of the initial debt financing.

My guess is that the benefits will outweigh the costs, but this may be a very challenging 20 years for the Chinese people.

Reasons why the Chinese model might work for other nations

1. When viewed at a very high level, China’s strategy is no different from what has been used by nations for 800 years.
   Copy what works in wealthier nations, and then use your low-cost labor advantage to export to the rest of the world. Then use what you learned to move into a similar but more profitable industry. Repeat. This is a time-tested model of development.

2. China no longer has a labor cost advantage. In fact, Chinese labor is now above average in cost. This gives room for new nations to learn how to compete in low-cost industries, such as textiles. Then the nation can learn by doing and then slowly ratchet up to higher value-added industries.
   It already seems likely that South Asia and Southeast Asia are already doing just that.

Reasons why China may be a unique outcome

1. Much of Chinese economic growth came from a one-time massive demographic expansion. Nations grow fastest when they have a large percentage of their population in the 30-60 age band. Those workers have acquired the skills and experience necessary to be productive workers, while seniors and children are a net drain on per capita economic growth. Workers aged 18-30 do not yet have the skills and experience necessary to be productive workers.
   To be clear, demographics do not cause economic growth, but in combination with other more important factors which I call the Five Keys to Progress, favorable demographics can significantly increase per capita growth rates. To keep the favorable demographics going, however, requires keeping the fertility rate above replacement rates, which nations are failing to do.
   The vast majority of nations today have declining birth rates and aging populations, so it is not clear that many nations can duplicate this happy coincidence that China experienced from 1990 to roughly 2010. Ironically, as those aged 30-60 Chinese workers move into retirement, this happy demographic coincidence will shift radically toward an inevitable demographic decline for China.

   

2. China has a heritage of Communist economic planning and a one-party state with no political competition. This is normally a huge economic disadvantage, but it did mean that if Chinese leadership desired to implement good economic policies, they could do so. Of course, if you look at history, highly centralized political institutions tend to implement bad economic policies, so this cuts both ways.
   In general, decentralization lowers the risk of bad government policies, but it also lowers the probability that really good government policies are implemented across the entire nation. From 1990 to at least until 2007, the Chinese economic policies got it right. The vast majority of centralized regimes do not.

3. I am no expert in monetary policy, but it is not clear that another developing nation can acquire such a huge debt load via domestic financing.

4. Nor is Foreign Direct Investment likely to risk putting such massive amounts of money in one nation. In general, foreign investors like to lower their risk by spreading capital among many nations with a reasonable chance of good returns, rather than just one. Perhaps a very small nation can get enough capital via FDI, but it seems unlikely that medium and large nations will.

5. Nor is it clear that massive debt financing alone in other nations will achieve the same economic results as China. I can absolutely see a developing nation thinking “All we have to do is go into debt, and our nation will grow economically as fast as China” while ignoring the other key factors. This will clearly not work.

6. The debt load that I mentioned earlier is a huge long-term constraint. China’s strategy may be a great medium-term industrialization strategy, but it could lead to a long-term dead end. That does not mean that the strategy is not worth following, but it shows the limitations of the strategy.

7. China’s productivity growth stalled in 2007 (after averaging 4.5% from 1990 to 2007), so the economic growth since then may not be sustainable in the long term. If the debt bubble pops, then China may return to a much lower material standard of living.

8. To industrialize, nations need to export goods. Typically, that involves manufacturing exports. For the foreseeable future, all nations must not only compete against Western corporations but also against Chinese corporations. This makes the global manufacturing market far more competitive than before 2000.

9. China has a population of over 1 billion people. It was practically a global economy in and of itself. This gave China much greater leverage over the wealthy Western nations than smaller countries. Once the economic growth started, China could say “Take it or Leave it” to Western corporations and investors. It is unlikely that other nations will have that luxury.

10. Chinese citizens have significantly higher average intelligence than other non-Western nations and this long preceded industrialization. Japan and Asian Tigers also had higher average intelligence. Indeed, all these nations have higher average intelligence than Western nations, and that likely was the case, long before the 20th Century.
    This means that these East Asia nations have a huge pool of high-intelligence labor for engineers to reverse engineer Western technologies, skills, and organizations. All that is missing is capital, which can be supplied by foreign direct investment. This likely played an important role in industrialization in the region.

11. In China, the government owns all the land, and the local government has the right to “sell” to individuals or organizations. This gives China a convenient way issue debt. A very significant percentage of the local government revenue to finance infrastructure investments comes from land sales and land value taxes. I am not familiar with land ownership patterns in all nations, but this is not possible in all nations. Or as explained by Dwarkesh Patel in a recent article.

In China, the government owns all land - when you "buy" property, you're really just getting a long-term lease. This lets provincial governments use a clever (but dangerous) funding trick: they borrow money against land they control, justifying high valuations by promising future infrastructure improvements will drive up prices. For years, this worked beautifully because property values kept soaring.

This system went into overdrive after 2008 when Beijing's stimulus plan essentially told local governments to go wild with infrastructure spending. They did exactly that, borrowing heavily against their land to fund endless construction projects. The result? Local governments are now sitting on a mountain of debt.

My best guess

My guess is that 100 years from now, economic historians will view China as an almost unique confluence of factors that other nations could not copy with any more specificity than what has already been done for the last 800 years:

1. Copy Westerners and East Asian technologies, skills, and organizations, but out-compete them in export markets with cheaper labor.

2. Invest heavily in infrastructure and export manufacturing, but in return demand that domestic companies show results in the international export markets.

3. If possible, attract Foreign Direct Investment. Otherwise, use domestic capital.

4. Gradually ratchet up the value chain toward higher value-added export products. Leverage the necessary technologies, skills, organizations, and capital from existing industries to learn the skills needed for the new industry and use the advantage of cheaper labor to outcompete richer nations.

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You can read more on how developing nations can experience material progress in this article.

If you enjoyed reading this series of articles, you might also be interested in reading my “From Poverty to Progress” book series:

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