Americans and Chinese Growth

If you want to talk job creation, let’s talk China. While the United States suffers through a prolonged jobless recovery, with another recession on the horizon, the Chinese economy has continued to boom. In the second quarter of 2011 the China’s GDP growth rate slowed to 9.5% year-on-year, down from 9.7% in the previous quarter and 11.9% a year earlier.

Double-digit growth rates are nothing new for China. Since launching game-changing economic reforms in 1978, China’s GDP has grown at an average of almost 10 percent per year. One driver of that growth has been vast additions to China’s productive capacity. For example, in 1979 China accounted for 4.6% of world crude steel production compared with 16.6% for the United States and 15.0% for Japan. China surpassed the United States in steel production in 1993 and Japan in 1996. In 2010 China’s crude steel production was 6.6 times its level 15 years earlier, and represented 44.3% of the world total, compared with 7.7% for Japan and 5.7% for the United States.

China’s growth has been also been sparked by technology transfer from the advanced economies. A prime objective of the 1978 economic reforms was to build the nation’s science and technology infrastructure, which was especially in need of modernization after the tribulations of the Cultural Revolution (1966-1976). In addition to launching a massive educational effort to increase the supply of scientists and engineers, from 1985 the Chinese government invited multinational corporations to invest in joint ventures with Chinese state-owned enterprises under the policy of “trading markets for technology” (TMFT). As the phrase suggests, the lure for multinationals was the potential to gain access to burgeoning product markets in a rapidly growing nation with one-sixth of the world’s population.

Quick to grasp the opportunity was the German automaker Volkswagen, which entered China in a joint venture with Shanghai Automotive International Company in 1985, followed by another one with First Automotive Works in 1987. By 2000 Volkswagen produced 52% of the passenger cars in China, most of them for government and taxi fleets. At the time, however, China’s car production represented only 1.5% of world production, and China ranked a distant 13th among all national car industries.

The past decade has changed all that. In 2010 China produced 13.9 million cars, 23.8% of the world total, about 37,000 cars greater than the combined production of Japan (8.3 million) as number two and Germany (5.6 million) as number three. Volkswagen produced 1.7 million cars in China in 2010, 2.8 times its production a decade earlier but now representing only 2.9% of total Chinese production. In the Chinese market Volkswagen was now second to (guess who?) the much maligned General Motors.

Back in 2000 GM produced just 30,000 cars in China, one-tenth of Volkswagen’s China output, and just one-third of one percent of GM’s worldwide production. By 2006 GM had surpassed VW in China, and in 2008 produced just over one million cars there, 17% of its worldwide total. Then in 2009 came GM’s bankruptcy, with its worldwide car production falling by 17%, even though its Chinese production rose by 69%! In 2010 GM boosted its worldwide car production up to 6.3 million, about a quarter of a million more than in 2008, before it went bankrupt. The 2010 total now included 2.2 million cars produced in China, 1.2 million more than in 2008 and 35% of GM’s worldwide production.

Bottom line: Without China, GM would still be in bankruptcy, and maybe even out of business.

At the same time, GM, VW, and other multinational corporations face lots of indigenous competition in the Chinese car industry. In 2010 no indigenous Chinese companies were represented among the top 15 car producers in the world, although combined the top 15 companies (six Japanese, three German, two each American and French, and one each South Korean and Italian) produced 8.6 million cars in China. Of the next 25 largest car producers in the world, however, 17 were Chinese, with a total output of 5.9 million cars, or 42% of China’s car production. (Note: There is some double-counting between foreign and indigenous producers because of joint ventures.)

These indigenous Chinese companies are the ones to watch. According to research by Kaidong Feng in his recent Sussex University Ph.D. dissertation on indigenous innovation in China, it is the indigenous Chinese car companies, and in particular nongovernmental enterprises such as Geely, Chery, and Brilliance, that have not been involved in joint ventures with multinational corporations, that are the most innovative in the industry, particularly in product innovation. Why? In joint ventures, domestic companies give up strategic control to multinationals. While under TMFT, multinationals are supposed to transfer technology to the Chinese, but they tend to keep the latest developments to themselves. When, as has typically been the case in joint ventures, the Chinese partners are state owned enterprises, the strategic mandate from the government has been to expand production capacity (stressing process innovation) rather than generate higher quality products.

In contrast, the nongovernmental enterprises can tap into the state-funded science and technology infrastructure for knowledge and people. They can access the national banking system for finance capital while maintaining their strategic autonomy from the government in the allocation of resources and returns. These indigenous companies, some of which succeed and many of which fail, seek to set themselves apart from the competition through innovation.

Dr. Feng has found similar results for the communications equipment industry, in which Huawei Technologies and ZTE are the most prominent examples, as well as, in collaboration with Qunhong Shen of Tsinghua University, for the electric power industry. A just completed study on the development of the Chinese semiconductor industry by UMass student Yin Li shows similar results. This recent research builds on and confirms the pioneering work of the late Qiwen Lu. In his book, China’s Leap into the Information Age, published in 2000, Lu documented and analyzed indigenous innovation in the rise of China’s first successful computer electronics companies during the 1980s and 1990s, including Legend (now Lenovo) and Founder (for a summary of Lu’s findings, see my paper, “Indigenous Innovation and Economic Development”). Going forward, state-of-the-art work on the subject will be the focus of a workshop on “Chinese ways of innovation” in Los Angeles in October.

As both response and encouragement to these developments in China’s technological capability, in 2006 the Chinese government made the promotion of indigenous innovation central to its

These advanced technology product imports and exports reflect the globalization of production since they include international trade in value-added components and work-in-progress along the global value chain. Through these production relationships, the economies of China and the United States are tightly intertwined, although with very different impacts on national economic performance. While China is leaping ahead, the United States is falling badly behind.

As William Greider warned in his best-selling book of 1998 on “the manic logic of global capitalism”, we live in “One World, Ready or Not”. In 2011 China’s innovative trajectory is ascendant, while the United States faces tough times. And don’t wait for China to implode: it won’t for a long time. Instead Americans should be thinking about how the United States can respond to the new competitive challenge. For a start, we need to invest the massive profits from globalization of US multinationals back in the United States.

That means not only policies for the repatriation of a substantial proportion of the foreign profits of US corporations, but also a coordinated and concerted national strategy for how these profits can be invested in innovation and job creation to get the United States back on track. The United States needs a national program of business-government cooperation to recreate what Harvard Business School professors Gary Pisano and Willy Shih have called the “industrial commons”. Or to echo Ralph Gomory, former president of the Sloan Foundation and head scientist at IBM, America’s response to the Chinese challenge requires an alignment of the interests of its companies with the interest of the country.

This article was originally published in the New Deal 2.0 blog.