After the Congress – Interpreting China’s new development concept

The 19th National Congress of the Communist Party of China (CPC), held in October 2017, was a milestone, establishing President Xi Jinping at the core of the Central Committee of the CPC and demonstrating that China’s development had entered a ‘new era’ of Chinese politics and power. 

The new era and Xi Jinping Thought 

The new era has many implications. First, the principal contradiction faced by Chinese society is now one of unbalanced and inadequate development and the people’s ever-growing need for a better life, rather than one of growing material and cultural needs and regressive social production. Second, China has undergone a tremendous transformation – it has stood up, grown rich and become strong. Now, more than ever before, China is closer to – and more confident and capable of – making the goal of national rejuvenation a reality.

To achieve the Chinese Dream of national rejuvenation, the report of the 19th CPC National Congress categorised future development in several stages from now until 2050. The initial decisive period for building a moderately prosperous society has been identified as being from now to 2020 and, from 2020 to 2035, China will develop into a modern socialist country with Chinese characteristics. And between 2035 and 2050, China will become a prosperous, powerful, democratic and harmonious socialist modern country.

To realise this aspiration, the 19th CPC National Congress adopted for guidance Xi Jinping Thought on socialism with Chinese characteristics for a new era. This addresses all aspects of Chinese economics, politics, culture, society and ecology, and is summarised in the ‘five-in-one’ overall arrangement, the ‘four comprehensives’ and the ‘five development concepts’, as put forward by President Xi after the 18th CPC National Congress in 2012. 

Five development concepts and supply-side structural reform

China’s future development can be defined by President Xi’s five development concepts. First, in the spirit of developing in the interests of the Chinese population, it is crucial to meet its growing needs for a better life. The way to development generally lies through promoting productivity, during which process, imbalance and inadequacy need to be resolved. The implementation of supply-side structural reforms is the effective way to deal with these problems. 

Supply-side structural reform demands the following five aspects: cutting overcapacity, limiting inventory, deleveraging, reducing costs and strengthening points of weakness. The first four aspects can help with the imbalance of capacity manifested between supply and demand – supply-side capacity needs to be adjusted according to demand. For inventory, the imbalance lies mainly between products and market demand. If production outgrows market demand, it leads to excessive inventory and waste, leading to essential cost-cutting. This is also a problem for deleveraging – currently, overleveraging reflects the imbalance between finance and the real economy, causing high leverage and accumulating excess financial risk. Reducing costs is necessary primarily because of the imbalance between business operations and governance. Enterprises must bear high operating costs as a result of ineffective governance and bad administration. Strengthening points of weakness is necessary to address inadequate development, meet demand and improve productivity.

The main route to resolving imbalance in supply-side structural reform is to deepen and further reform. And strengthening areas of weakness is the way to pursue development in accordance with the five major development concepts: innovation, co-ordination, greenness, openness and sharing. 

These concepts contain approaches and objectives – ‘approach’ indicates the innovation that can boost productivity, and the ‘objective’ is to avoid overcapacity and excess inventory by co-ordinating supply and demand. At the same time, development must be green to meet the population’s desire for a better life. In addition, foreign and domestic resources and markets should be used fully in an open economy, and the fruits of development shared by the people.

Five categories of industry and innovation

From an economist’s perspective, innovation means introducing more advanced technologies for future use and entering industries with higher values than the existing ones – also known as industrial upgrading. There are two ways of achieving technological innovation. On the one hand, if existing technology is cutting-edge, innovation simply means invention. On the other, if there is a gap between existing technology and the world’s frontrunners – as an alternative to invention – innovation can be achieved by introduction, digestion and absorption. 

‘New Structural Economics’ divides the industries in an upper middle-income country such as China into five categories. The first is catch-up industry, which exists in more developed countries as well as in China. For example, China is the world’s major producer of construction equipment, while Germany is also a leading player in this field. A piece of equipment made in China costs US$1 million, while in Germany the same piece costs US$5 million. Therefore, China is still at the stage of catching-up.

The second is ‘leading-edge’ industry. China has several world-leading technologies, including the household appliances industry – televisions, refrigerators, washing machines, and so on – and high-speed/bullet trains. 

The third is transformative industry, which refers to industries that have lost their leading-edge position because of a change in comparative advantages.

The fourth category is corner-overtaking industry, which is characterised by a short cycle of new technological development and product upgrades, and depends mainly on human capital. As an upper middle-income country, China is relatively close to developed countries in terms of human capital. But for financial and physical capital, this is different. Developed countries have been accumulating this for more than 300 years; in contrast, China began accumulation only after the the beginning of the reform and ‘opening‑up’ period in 1978, which has created a huge gap between China and the developed countries. When the invention of new products and technologies requires intensive human capital and has a short cycle, from the perspective of factor endowment, developed countries fare no better than China. For this kind of short-cycle industry, which requires low financial investment and uses human capital as input, China’s considerable advantages are its large population – containing many talented people – and a large domestic market for new products. China also produces the most complete set of intermediate products, so when products have hardware demands, China has obvious advantages. 

The final category is national defence, security and new strategic new industry. This industry is precisely the opposite of the corner-overtaking industry. It too requires high human capital, but its research and development (R&D) cycle is particularly lengthy, requiring 10 or 20 years and a huge amount of financial investment and physical capital. From the perspective of factor endowment, China currently has no advantage in this industry. There can be no guarantee of national defence and security without products purchased from abroad; therefore, China needs to support its development even if it is not currently in a favourable condition.

For new industries not necessarily relevant to national defence and security, their R&D cycles are also long and require huge amounts of financial and physical capital. Theoretically, China has no advantage, but the importance of this industry for economic development and the direction of its innovation is clear. If China does not enter this strategic industry now, developed countries will occupy the strategic high ground and, in the future, when China is ready, it may lose the right to access or the industrial technology will be too expensive to acquire. In this sense, even if China currently has no advantage, its cost and risk will be huge in the long run if it ignores this strategic opportunity of investment.

Five categories, five types of innovation

These five categories in China’s existing industries each require different types of innovation. Innovation in catch-up industry is primarily based on introduction, digestion and absorption. The leading-edge, corner-overtaking, and national defence and strategic new industries rely mainly on indigenous R&D. For transformative industry, innovation can comprise entering at two ends of the ‘smiling curve’, including branding, product design and marketing channel management, which require product R&D and innovation in management. Or it can be transferring low value-added labour-intensive production into other domestic areas – or foreign countries where income and wages are relatively low – which requires process and management innovation according to local conditions. Applying different innovations can help a nation to become highly efficient.

In the process of innovation, there is a need to consider new platform technologies, such as artificial intelligence and the opportunities provided by the internet, and the whole process must be accomplished using green technologies. Only in this way can China achieve the goal of innovation, co-ordination, greenness, openness and sharing required by the five major development concepts.

The main route to resolving imbalance in supply-side structural reform is to deepen and further reform

Innovation and finance

Innovation requires capital investment, and therefore should be integrated with finance. Catch-up innovation is based on introduction, which requires bank loans or bond issuance, and banks have size differentiation, depending on the scale of enterprises and their needs for capital. For example, when a large enterprise carries out catch-up innovation, including mergers and acquisitions and other means, loans from large banks will be the main source. And when a small business carries out catch-up innovation, small and medium-sized banks can meet their needs. For the innovation of leading-edge and corner-overtaking industries, their indigenous innovation requires different financial sources. Enterprises in leading-edge industry are usually quite mature, and the capital demand depends mostly on financing in stock markets. For enterprises in a transformative period, for example, developing new products or marketing channel management and quality management, banks will provide major support. Corner overtaking requires indigenous innovation, and fundamentally relies on angel capital or venture capital to absorb risk. In national defence, security and strategic new industries, innovation demands government financial support since they currently lack comparative advantages, and financial support is mostly via direct fiscal subsidies. Governments can set up funds to subsidise R&D or provide financial support through procurements.

Realising prosperity

China needs to innovate in various ways as it enters the new era proposed in the report of the 19th CPC National Congress, they are needed to realise the Chinese Dream of national rejuvenation, to make China stronger and to endow the Chinese people with a better livelihood. Different types of industries require different ways of innovating. Finance serves the real economy and should support innovation with arrangements appropriate for the correct type. Furthermore, if China can carry out its innovations in accordance with the other major development concepts – co-ordination, greenness, openness and sharing – the great rejuvenation of the Chinese nation and the goal of making China stronger will assuredly be realised. 

This article is part of The IFF China Report 2018, which draws mainly on content provided by China-headquartered think tank, the International Finance Forum, and is published in association with Central Banking.