How China can be more self-sufficient in tech development

The key pillars of China’s 14th five-year plan were unveiled this week. One of the most eye-catching components is technological development and self-reliance, which has been elevated to a national strategic pillar. Although the development of cutting-edge technologies was highlighted in previous five-year plans, new tech priorities in the latest plan have attracted renewed attention against the backdrop of escalating China-US tensions. Facing the risk of widening restrictions, it is increasingly critical for China to develop domestic capacity and reduce its dependence on foreign technology. Despite strong commitments from Beijing, it is unclear whether China can achieve self-reliance in a variety of areas, with semiconductor chips top of the list. Given the large gap between China and the United States in the semiconductor industry, China will have to make gigantic investments over a long period to catch up. The recent policies suggest China is resorting to its unique “whole-nation system” to finance technology development, even though the efficiency and effectiveness of this system remains under debate. China is well positioned to develop high-end technologies and improve its self-reliance. Economies of scale provide a considerable advantage in technology competition. For advanced technologies, such as semiconductor chips, high front-end investment is required to establish research and production facilities while marginal production costs will decline quickly after the supply chain reaches a certain scale. As the world’s largest single market in terms of population and GDP measured by purchasing power parity, China’s domestic demand should be sufficient to support technology firms in reaching economies of scale. One example of the importance of economies of scale is the development of China’s internet sector. Thanks to heavy state investment in the infrastructure, access to mobile services quickly became widely available to the public, including people in remote regions. On this basis, domestic internet giants have been able to provide services to nearly a billion people, with the average cost per client declining steadily. When mobile internet penetrates nearly every aspect of people’s lives, aggregate tech company profits grow rapidly and, in turn, support the development of new technologies. Economies of scale also serve as preconditions for technological development, and the Chinese government plays a considerable, albeit controversial, role in turning these preconditions into reality. The government adopts a wide range of approaches in tech development, such as offering tax incentives, subsidies, seed funds and direct investment by state-owned enterprises or public-private joint ventures. In taking this major role in providing initial investment, Beijing effectively assumes the financing risks. While such tactics can generate powerful momentum, controversy surrounds the efficacy and efficiency of such central-government-led activities, as well as the burden it places on local government debt levels. China’s track record in key technology sectors such as solar power, LCD panels and new energy vehicles has exemplified the benefits of the government-driven development model. Local governments’ huge investment in tech has resulted in cycles of bubbles, subsidy scandals, growing debt and sector reshuffling, forcing some local governments or their state-owned enterprises involved in these sectors to exit the game. However, sector winners did finally emerge from the competition and benefit from the economies of scale in mature domestic supply chains. All these success stories suggest enormous potential for China to develop its tech system on the basis of its economic scale and quickly mobilised, government-driven model. However, given that China is at a higher position in the value chain than before, investment on a larger scale and over a longer period is inevitable. This implies higher risks of unsustainable government debt, which might interrupt the tech development process. Why semiconductors are important in the US-China tech war As a result, the government needs to adopt a smarter investment system for higher efficiency and less waste. In recent years, government investment funds have taken a more market-oriented approach with closer public-private cooperation to improve investment decisions. The fiscal supportive measures have also evolved to avoid policy arbitrage and subsidy scandals. As long as the investment system keeps on this track, it is reasonable to be optimistic about China’s domestic technology development. Chaoping Zhu is a Shanghai-based global market strategist at JP Morgan Asset Management